ACCO 420

POST MIDTERM

Week 6 – Chapter 5
 CALCULATING NCI (Non-controlling interest)
 May not buy 100% but still majority stake and must consolidate
 How do we do a consolidation if we do not buy 100% of the shares?
 Consolidated statement had P’s net assets at BV and Subs net assets at FV
 100% of P, and 100% of S

EXAMPLE: What is P buys 80% of S, what should the consolidated statements show?

 Proprietary theory = based on ownership (what percentage do you own of the

subsidiary theory) so the parent must consolidate the FV of net assets at the sub at the
percentage of what they own
 Used to use this method for joint ventures but now we use equity method instead
 Accounting looks at control not ownership
 Entity theory = the consolidated statements shouldn’t be looked at from the perspective
from the parent but instead of the entity as a whole therefore all of net assets of the
entity must also be reflected. (What you have control over vs what you own)
 ***GAAP used the entity theory
 Parent/Company concept = You own 100% of the shares of a subsidiary but the
percentage you own remains at FV and the remainder stays at BV (80% vs 20%)

 OPTION #2 (entity theory)

 P+S-ADJ = Conso
 The investment in subsidiary account holds the amount we paid for the investment in
the sub (80%)
 Must of also removed R/E and C/S based on 100%
 Net assets would’ve been accumulated at 100%
 Fair value adjustments would have also been picked up at 100% as well as the goodwill
 In order to balance these 100% accounts with the investment account at 80%, we must
make an adjustment of 20% of subs total net assets (CREDIT)
 ??????
 P&S are one economic entity
 Non-controlling interest will be a separate line on the balance sheet and will ONLY show
up on the consolidated statements (this is the amount of the net assets NOT owned by
the parent company)
**could be negative amount
 Chapter 5 focuses primarily on the equity section of a consolidated entity

Partial Goodwill Method (IFRS)

 First step is still the acquisition analysis
  Must state your consideration transferred but now at 80% (or the percentage you paid)
 Following this step, net assets (book value vs fair value) must be valued at 80%
 80% of the FVNIA BUT the financial statements must be at 100%

Full Goodwill Method (IFRS)

 must use the consideration transferred as your 80% and then must get the fair value of
the NCI portion for the remaining 20%
 easier for a public corp because their stock information is available online
 then the FVNIA will be based on 100% and therefore the goodwill will be based on 100%
too
 If goodwill (asset) is higher than what we actually own in shares, we must increase NCI
in the equity section in order to BALANCE

 companies have a choice between these methods, it is an accounting policy choice

 it is more difficult to find the fair value of the NCI portion for private companies
therefore may use the partial goodwill method
 ASPE is private corps so they most likely use the partial goodwill method
 The full goodwill method will also create a larger asset on a company’s financial
statements which will affect related ratios
 The further you get away from 100% the less likely you should be using the full goodwill
method because we are adding additional amounts that we do not control on our
balance sheet
 We only own 80% therefore adding the remaining 20% in which we do not own is
overinflating our investments and our assets
 We could also not own any shares but still have control (as seen in chapter 1) and this
would be a complete inflation of our investment (MISREPRESENTATIVE)
 FVNIA = fair value of net assets BV vs FV
 FV in total = FVNIA + goodwill

Statement of Changes in Equity

1. Capital Stock
 Parents beg capital stock will remain at 100%, no adjustments needed
 NO CHANGES
 Parents end capital stock will remain at 100%, no adjustments needed
2. Retained Earnings
 Parent owns 100% of their own R/E but only a percentage of the subs
 We must add P + S beg R/E then must adjust S R/E
 We adjust the subs assets fair value and the pre-acquisition adjustments
 Ending R/E depend on the intracompany transactions that occurred in the prior year
 If parent sells to sub this is a downstream transaction so the unrealized profit goes to
parent
 If sub sells to parent this is a upstream transaction so the unrealized profit goes to sub
  At the end you total the adjustments and you multiply the subs amount by the %
 When you bring this amount over to the parents amount, you will get beg R/E for the
entity as a whole

 For consolidated net income we must ALSO adjust

 We must split the income based on what amount belongs to each the sub and the
parent THEN make our adjustments
 We add the FVA to the subs net income
 Then make the downstream or upstream adjustments
 Subtract any unrealized up or downstream income
 WE MUST ALSO REMOVE THE DIVIDEND REVENUE from the parents NI (at the
percentage of what they are due)
 Sum it up

3. Cumulative other comprehensive income

 Start with beginning of parent and sub
 Must remove any of subs OCI at pre-acq
 Take 80% of subs column and add it to parents for beg OCI

4. Non-controlling interest
 Must first calculate beg NCI
 We start with NCI at acquisition (based on acquisition analysis)
 This will be affected by the partial goodwill method or full goodwill method (FV or
FVNIA)
 Must take total sub beg R/E to parent (1-80%) in order to get beg NCI
 Must also look at subs total net income because 20% will go to parent AND 20% of OCI
 Then will remove dividends (20% of div paid by sub)
 All of this will give ending NCI

 The statement requires us to show the beginning balance, any changes and then the
ending balance which then goes on the balance sheet
 P5-1 & P5-4

Week 8 – Chapter 6
 We use the Equity method when it is an associate or a joint venture
 No longer looking at parent/sub relationship (no consolidation)
 Under ASPE, we can still use the equity method for parent/sub relationship

Equity Method
 Start with the investment account at what we originally paid
 You would then add your share of the profits
 Then subtract your share of any dividends
 This would equal your INVESTMENT ACCOUNT
  For consolidation we took Parent and subs net income then added them
 If we owned less than 100%, we would split the net income between parents ownership
and NCI
 The EQUITY METHOD aims for the same end result
 The net income must have the same adjustments as it would have had on consolidation
 Must take the associate, start with their net income and then must make corresponding
adjustments (FV Adjs, Realized & unrealized profit) and after adjustments will pick up
your percentage
 There are only 2 accounts we are able to adjust for the Equity Method: share of profit or
the investment account *****
 For the investment account, we start with the original cost and each year we pick up a
certain % (less our % of dividends)

Original Cost
Beg R/E
Less: Pre-ACQ R/E
FVA x %
Unrealized profit x %
= Beg investment account
+ Share of profit
-Share of dividends
= End Investment Account

 This is the same NCI calculation as for consolidation but now it is titled the investment
account
 We must look at BOTH upstream and downstream transactions for the equity method
(not only upstream like consolidation)
Week 9 – Chapter 9&10
 NON-PROFIT ORGANIZATIONS
 A charity is a TYPE of an NPO but it is not the definition

 CANNOT be shareholders or residual owner in an NPO

 Example of a social aspect is JMAS
 Example of health aspect is Alcoholics Anonymous
 What makes an NPO a charity? If not social, health, etc.
Must meet the criteria listed by the CRA in order to qualify for an NPO
 People are more encouraged and likely to donate if they will receive a tax credit from
the donation
 Must look at structure and how it was formed in order to deem whether it is an NPO
 CPA ORDER is an NPO (not a charity but formed for the purpose of aiding accountants
and get funds from due fees)
 We must understand what the reporting is for an NPO and why
 NFPO = Non-for-profit organizations
 Can be divided into (1) private vs (2) public
 Public organizations are controlled by the government (fed, provincial or municipal
government)
 Chapter 9 = private NFPO’s
 Chapter 10 = public NFPO’s
 All public schools are public NFPO’s (including universities)
 For Concordia, the provincial government is in control
 Hospitals are also public sector NFPOs
 CPE’s (daycares) are allowed to be classified as private NFPOs
 Public sector follows the public sector accounting standards
  A private NFPO is allowed to follow IFRS or Accounting standards for NFPOs part 3
 Part 1 = IFRS framework, Part 2 = ASPE framework, Part 3 = NFPO framework only for
private), Part 4 = Pension Plan Reporting
 Note 1 of any financial statements state which part of the accounting standards it was
prepared using
 Part 3 is a partial handbook, only has certain sections
 Whatever sections are not covered in part 3, must be used using part 2

 How does private NFPO choose between IFRA AND PART 3?

 Over 95% of NFPOs use part 3
 NFPOS use IFRS bcs they are international/multinational/global

 What information from an NFPO is important to users?

 Where expenses are being allocated to ensure that they are serving the community as
they say they are
 Not using the money attained for personal reasons
 Stewardship becomes extremely important
 NFPOs are much more higher risk for stewardship
 We need a metric to measure an NFPOs success in achieving what they promised
 This is why accounting is different for NFPOs
 We must present information that is USEFUL to user
 It is difficult to identify users in order to know what they need as information

FUND ACCOUNTING
 Only available to NFPOs
 Part of PART 3
 Its an accounting policy
 We don’t need to do fund accounting but can choose to do it if we believe it is
meaningful
 Fund accounting allows for us to split our financial statements into several funds (fund
A, B, C, etc)
 Combined they equal a total for the entity
 How they are split is based on activity
 EXAMPLE: Schools
some examples of activity’s include scholarships, field trips, extracurricular activities,
capital assets (to maintain the building/premises)
parents want to ensure that their school fees is going towards these activities

 The biggest fund is often capital assets like buildings/infrastructure

 Religious institutions often ask for donations to maintain their infrastructure which
doesn’t necessarily contribute to their mission

 NFPOs present the same FS as a regular company

 They have a balance sheet, a statement of operations (income statement), statement of
cash flow and statement of changes in net assets
 For a balance sheet, we have assets and liabilities but NOT EQUITY because there is no
ownership aspect (shareholders)
 Equity is then called net assets (A-L) or fund balances instead

 First major issue with NFPOs is revenue recognition

 Three criteria exists to recognize revenue
1. Collectability assured 2. Reasonably estimable/measurable 3. Performance achieved
 This follows the ASPE framework
 Specifics have to do with a unique type of revenue; contributions
 Contributions rarely exist for profit enterprises
 Contributions = amounts received with no reciprocal transaction, will get something for
nothing back in return
 How do we recognize revenue when we receive something in exchange for nothing?
 ISSUE #1
 Regular companies can receive donations and government grants which are examples of
contributions
 This is an occasion where we can use part 3
 We must be sure that we can measure it as well as reasonable assurance of collectability
 EXAMPLE: PLEDGES
 Pledges = a promise or undertaking that another entity will give money, request for
money
 Pledges are measurable but do now have a reasonable assurance of collectability
 Pledges are normally not recorded as revenue until ACTUALLY collected
 EXAMPLE 2: BEQUEST
 Bequest = inheritance, when someone upon death provides money to charitable
organizations, stated in their will
 The organization that was donated to cannot recognize the revenue until they receive
the cheque because family and other inheritors will most likely fight such a request
legally
 Government grants are treated the same way as donations
 EXAMPLE 3: Government grants
 We know we will only be collecting the grant halfway through the year
 In this case it is measurable as well as reasonably assured that we will collect it at a
certain time BUT some might prefer to wait if the grant actually comes in (DEBATABLE)
 Some NFPOs want to show revenue and others do not for their own reason

 The biggest issue in PART 3 is how to present each of these type of contributions in
different ways
 ISSUE #2
 Relates once again to contributions and the different types
 Types include: unrestricted, restricted and endowment
  Unrestricted = The NFPO can do whatever they want with this money, they can choose
where to put it
 Restricted = can be externally or internally restricted, external means the contributor
has put restrictions on their donation vs internally
 Any excess amounts for restricted donations must legally be given back to donors
 NFPOs most often call back the donors they know will not take the money back but
without that approval form the donors they can get into big legal trouble
 Endowment = “a legal structure for managing, and in many cases indefinitely
perpetuating, a pool of financial, real estate, or other investments for a specific purpose
according to the will of its founders and donors”
 Cannot spend such investments/cannot spend principal, only the growth from such a
contribution
 Such contributions are meant to help continuously, not once or one year
 The point is to be able to live off the growth
 A lot of NFPOs have endowments but they are cash poor, they completely rely on
interested earned
 How these contributions are presented
 The handbook allows us 2 options: the deferral method VS the restricted fund method
 These are different options of presentation for RESTRICTED CONTRIBTUONS
 Deferral method can be done with or without fund accounting (doing funds by the
activity)
 Deferal method is a matching concept (rev and exp.)
 The restricted fund method MUST be used with fund accounting AND must have
minimum 3 funds (general fund, restricted fund which must be based on external
restrictions and endowment fund)
 Unrestricted contributions are always revenue immediately

Deferral Method Deferral Method Restricted Method

(NO FUND ACCO) (WITH FUND ACCO) *FUND ACCOUNTING

1. Gov grant DR Cash 100,000 DR Cash –gen 100,000 DR Cash – gen 100,000
($100,000 CR Contrib. rev 100,000 CR Contrib rev – gen 100,00 CR Contrib rev –gen 100,000
for
anything)
2. Donor A DR Cash 200,000 DR Cash – capital asset fund DR Cash – capital asset fund
gives CR DEFERRED rev 200,000 200,000
$200,000 to 200,000 CR DEFERRED rev – capital CR Def rev – capital asset
buy building (def rev is a liab on BS) asset fund 200,000 fund 200,000
 RESTRICTED **we recognize rev
immediately, not deferred
3. We use the DR. Building 200,000 DR. Building 200,000 DR. Building 200,000
$200,000 to CR Cash 200,000 CR Cash – cap asset fund CR Cash – cap asset fund
actually buy 200,000 200,000
the building

4. Annual DR Deprec 40,000 DR Deprec – cap asset fund DR Deprec – cap asset fund
depreciation CR Accum dep 40,000 40,000 40,000
on the CR Accum dep – cap asset CR Accum dep – cap asset
building DR def rev 40,000 fund 40,000 fund 40,000
CR Contrib rev 40,000

5. If B gives an DR Cash 50,000 DR Cash –endowment fund DR Cash - endowment fund

endowment CR Net assets 50,000 50,000 50,000
of $50,000 *cannot put to deferred CR Net assets – endowment CR Contribution rev –
account bcs will never fund 50,000 endowment fund 50,000
have an
expense/revenue that
relates

 Which of the 3 methods is going to record revenue early? The restricted fund method
 Some want to show revenue and some don’t
 An accounting policy choice if we get contributions that are restricted

Issues cont’d
Inventory (PART III)
 Under ASPE, we initially record inventory at cost and at every Y/E we must do valuations
at LCNRV
 NFPO’s also record inventory the exact same way
 ISSUE: What if the inventory is donated?
EX: Salvation army runs a used clothing store which the merchandise is donated
 To record such an acquisition of inventory, you treat it like a contribution
 It is an accounting policy decision
 OPTION 1: No recognition or entry
 OPTION 2: Record it at FV (BUT only available if can be measured and part of normal
course of operations
 Why would they choose one versus the other? (in terms of options concerning
accounting policies) BOTH MUST BE MET
 What does the NFPO want to show the donors in these type of situations?
 No net impact bcs they’re being donated so rev and COGS will net out BUT IS a
disclosure impact
 ***Most NFPOs choose to not recognize such donated inventory
 ISSUE #2: Exists if you do choose to recognize it, if you get inventory that you recorded
at FV and then plan to give it away, should we be doing LCNRV?
  We should record at RC (realized cost?)

Service (Volunteers)
 Another form of contribution
 Rather than provide inventory or cash, they provide their services
 How does the NFPO record the services that they receive?
 Accounting policy decision
 OPTION 1: No recognition or entry
 OPTION 2: Record it at FV (BUT only available if can be measured and part of normal
course of operations) BOTH MUST BE MET
 **Most NFPOs choose to not recognize such services, too difficult
 the ONLY position that is required and will be hired if no one volunteers, is an
accountant/bookkeeper

Property, Plant, Equipment & intangibles

 under ASPE, we record PPE and intangibles initially at cost and then depreciate
 We also test for impairment @ Y/E
 Normally we depreciate over the useful life which is based on the specific entity
 For NFPOs, the useful life revolves around how long that NFPO is actually using such PPE
and intangibles
 What happens if it is donated?
 It would be considered a contribution of PPE or an intangible
 MUST record at FAIR VALUE
 Dr. Building CR. Contribution revenue
 Here we will always be able to measure it therefore will always record for NFPOs
 Only likely for intangibles
 Since PPE is a major item, it is important to have it on FS
 EXEMPTION: If NFPO revenue is less than $500,000 average for the last 2 years, they do
not have to capitalize PPE or intangibles (expense immediately)
 This amount can be deemed as a small NPO (< $500,000)
 This exemption is an attempt to give smaller organizations an easier method to
accounting for these items (not preferred method though)
 Once you capitalize, you cannot go back and expense
 COLLECTIONS (type of PPE and intangible)
 Criteria
1. Held for public exhibit or educational or religious purposes
2. They are protected, cared for and preserved
3. There is an organizational policy that states that any funds on sales in the collection is
used to buy items for the collection or to preserve the collection
 EX: MUSEUMS
 NO DEPRECIATION in collections
 Another accounting policy decision
 OPTION 1: Record at FV (must be measurable)
  OPTION 2: Record at a nominal value
 Recording at a nominal value is just so that there is a line item representing such items
and that readers know that they exist, rather than place dependency on their value or
cost
 Many of these items are priceless so to determine their FV is difficult and not
meaningful (not worth the cost to find out how much they’re worth
 ALSO the dollar value does not matter to readers/FS users
 Users care more about if they operated in an efficient and effective manner

????i
 NFPO can be split into NPO or profit
 If NPO’s have the same board of directors, it can be presumed that one owns the other
 BUT must look at other factors such as economic interest, integrated, charter or bylaws
 Why does it matter to an NFPO?
 If an NPO is deemed to own another, they have another accounting policy decision
Not for profits
 OPTION 1: Consolidating
 OPTION 2: Note disclosure
For profit orgs
 OPTION 1: Consolidating
 OPTION 2: Use the equity method
 Most NFPOS do not want to consolidate because they wish to seem like they have less
than they actually do so that they are able to get more donations and government
grants
 Consolidation lets these large amounts be shown on their FS
 For both non-profit and profit orgs
 Can show expenses by activity (selling, admin, financial, etc) or nature (salaries, deprec.,
interest, etc.)
 An NFPO is mandated to allocate expenses and inform the reader on how they allocated
activities and expenses
 This is important because readers want to know where their money and donations are
going (want to see if the funds are being spent effectively)
 Users want to know if it was worth hiring such a fundraiser

Public Sector
 Controlled by government
 The main difference of a public-sector FS is that the users want to be sure that the
government spent the money the way they were supposed to
 Major differences include:
1. Public sector never has to worry about revenue because they will just tax more to get
it
 2. The government always puts the budget on there is as a separate line (only org that
does this)
 The budget for a government is their policy statement for the year
 This is how the gov. outlines what’s most important and how they plan to spend their
money
 Budget is placed next to actual figures for comparison
 When not within budget the future people who live in the city will pay higher taxes OR
they will have to cut items from their future budget

WEEK 10: Chapter 7 Foreign Currency

 FS are made to show the readers RISK
 Types of Risk
1. Credit Risk
 The risk that the other party to the transaction will not fulfill their obligation
 How do we show this on a financial statement? In the allowance for doubtful accounts
2. Liquidity Risk
 The risk that I, the company, will not fulfill MY obligations
 Cash cannot meet the debts and liabilities they owe
 How do we show this on a financial statement? Current vs Long term assets and
liabilities, which one are due NOW
 Also a statement of cash flows
 Liquidity ratio
3. Price risk ***
 The risk that the value of the item will change
 Three type of price risk: interest rate risk, foreign currency risk and market risk
 When a user is looking at an amount on the FS, users want to know if this amount risks
changing
 If the interest rate changes, bonds payable and receivable as well as loans
 Loans specifically that would have a change in value if the interest rate changes
 Fixed interest rate loans and bonds do not apply
 Shares and securities value will change if the market changes as well
 These items would be revalued at balance sheet dates
 This is what we report, the change in valuation
 The value of the item will change if the foreign currency rate changes
4. Cash Flow Risk
 The risk that the expected cash flow is not the actual cash flow received
 Variable interest securities would directly be affective and reflective of this risk

FOREIGN CURRENCY RISK (main topic of discussion)

 Must exist if were dealing with foreign currencies
  Functional currency = where a company conducts their primary economic activity, every
company determines its OWN functional currency
EX: Depanneur in MTL conducts its primary economic activity in Canada BUT the
majority of its customers are form a certain foreign country and they accept that foreign
currency at times instead of CAD
 HERE, it may be difficult to argue that this depanneurs functional currency is CAD
EX 2: Online websites that ship internationally and allow consumers to pay in all
different types of foreign currency, what would be its primary economic activity be?
 Two primary indicators for economic activity
1. Where does the company conduct their sales? Where is the sales price determines?
2. Where are the companies expenses and salaries paid?
 Secondary indicators
1. Where does the company obtain their financing?
2. Where does the company keep excess funds?
 If after both these indicators, one cannot still determine their economic activity, IFRS
states that it is based on professional judgement
 This all allows for us to conclude what is the functional currency
 ASPE assumes that the functional currency is the CAD dollar, therefore these indicators
do not exist for a company practicing ASPE
 We will assume in this course that the functional currency is CAD
 Any transaction that is NOT in the functional currency is a foreign currency transaction
 Foreign currency transactions are often the transactions that cause foreign currency
RISK
 If the transaction is foreign, it is initially measured at the spot rate (which is the rate on
the transaction date)
 The handbook also allows us to take an average rate (average for the month, year, etc.)
 BUT today, computer systems automatically translate these amounts each day as long
as the sale is properly classified in the system
 Once we have done these calculations, how do we show the reader that there is a
foreign currency risk?
 Monetary vs Non-monetary transaction
 Monetary = fixed in amount by contract and therefore will vary in value
 Fixed in the foreign amount so can only sell the item for what you paid it which leads to
a FOREIGN CURRENCY RISK
 Changes CAD value not foreign
 Non-monetary = NOT fixed in amount by contract and therefore will maintain its value
(allowed to fluctuate)
 Not fixed in the foreign amount, so I should be able to sell that item for the difference in
the foreign rate fluctuation so NO FOREIGN CURRENCY RISK
 Changes foreign value, NOT CAD
Financial Statement Items
 Cash = monetary, it is printed and that it also a form of contract
EX: 1,000,000 USD will change its CAD value but never its USD value
 A/R = monetary
 Inventory = non-monetary, the value can fluctuate, we can sell the inventory for
whatever the company wishes to
 PPE = non-monetary, can sell the land for the difference in foreign rates allowing the
CAD value to stay the same
 Intangibles = non-monetary
 Pre-paids = non-monetary, right to receive a service not a cash amount therefore cannot
lose any monetary amount or value
 Goodwill = non-monetary
 A/P = monetary, a contract exists
 Long term debt = monetary, a contract exists
 Deferred taxes = non-monetary, cannot form a contract with the government
**Non-monetary items protect company better from fluctuations in foreign currency
rates
 Monetary items also lose purchasing power with inflation, same type of risk, losing
value of what you hold

EX: On Sep 1st A sells $10,000 USD to B

On December 31st is the year 1 end
On Feb 1st year 2, B pays for the goods

FOREIGN CURRENCY @ DATE

Sep 1st 1 USD = 1.26 CAD
Dec 31st 1 USD = 1.22 CAD
Feb 1st 1 USD = 1.25 CAD

CALCULATIONS: $10,000 * 1.26 = $12,600 CAD

DR A/R 12,600
CR. Sales 12,600
 st
On December 31 , Y/E we must show the reader any risk that may prevail from this
foreign transaction
 Must re-measure monetary item to its current CAD equivalent
DR. Unrealized foreign currency loss 400 CAD (10000*1.26 – 10000*1.25)
CR. A/R 400 CAD

 Balance sheet = A/R $12,200 CAD (12600 – 400 loss)

 CANNOT TOUCH SALES, bcs this amount of money lost had to do with the fact we didn’t
collect immediately
 The loss will be on LAST YEARS income statement
 DR. Cash 12,500 (10,000 USD * 1.25)
CR. A/R 12,200
CR. Realized loss on foreign currency 300
 This loss will be on THIS YEARS income statement
  Total loss : 12,600-12,500 = $100 CAD

HEDGING
 Hedging = The action of eliminating/removing risk
 How does one reduce credit risk?
- Conduct credit checks prior to a sale
- Offer discount for faster payments
- Not offer credit as a method of payment (cash on delivery)
 Each company has a different level of risk their willing to take on
 Liquidity risk is that you cannot pay your bills when they come due
 How does one reduce liquidity risk?
- By not spending or borrowing any money, no bills to be paid
 This makes it hard for a company to grow or operate without any purchases or funds
 How does one reduce foreign currency risk?
- Not conduct foreign currency transactions
- Use a fixed rate (lock in the rate with a forward contract/derivatives)
- Set up an equal and opposite position cash account abroad (if you lose on one side,
you will gain on the other since you have accounts in both currencies) *NATURAL HEDGE
 The issue is that markets are small in Canada so companies are often forced into foreign
currency transaction
 Companies that export and import must also enter foreign currency transactions
 Natural hedging makes us never use CAD cash since we have foreign currency sitting in
this other bank account abroad
 When the company put money in this foreign bank account, they incurred a loss at THAT
time, this was the only time
 Companies decide WHEN they put money in this bank account, therefore they choose
when the rates are good to put in and bad for when to take out
 How do we tell the reader that we have no risk?
- At the end of the year, the foreign bank account is a monetary item so we must restate
it at the end of the year, the difference will be a gain or loss
- Payables are also monetary items so we must also restate them and will lead to a gain
or loss, which each will net out showing that there is no foreign currency risk
 HOWEVER, will never be perfect due to the timing issue
 The timing of when we put $$ into the foreign account will not be the same as when we
have to pay foreign bills
 ANOTHER ISSUE is that the amounts will never be exactly the same, in terms of payables
and receivables
 Effective of a hedge is based on timing and amount
 It is rare that this will happen but must try best to have equal and opposite accounts
 Companies might often borrow in foreign currencies to have this offsetting position
 Many companies do not have this ability so they are often one sided
 What these companies do is MANUFACTURE A HEDGE (derivatives)
 TYPES OF DERIVATIVES
 1. Futures
2. Options (expensive)
3. Forward contracts

 FORWARD CONTRACTS
EX: Buy 10,00 USD goods with payment due in 3 months
 We buy a contract where the banker sells us $10,000 USD and in the contract, it states
that we will pay for this $12,500 CAD
 Here we are reducing the risk by knowing how much it will cost us in 6 months
(unknown =RISKY) PRO
 CON = it is difficult to gage the foreign exchange rate in the future and difficult to reflect
opportunity cost, this is why not everyone takes on the contract
 Opportunity cost is if the rate was better than what we locked in, how much we
could’ve paid instead and saved
 Broker also takes on foreign currency risk and they charge for the contract
 The forward rate includes a premium to compensate the broker to take on the risk
 Is it worth it for the company to buy the contract to eliminate the risk?
 This what the companies are doing so HOW do we reflect this to the reader?

Accounting for derivatives

 We buy derivatives in the hope they will go up or down for profit
 Speculative PURPOSES
 How we account for this?
 Record the same for futures, forwards and options
 We record these contracts on the day we enter the contract (even though cash has not
changed hands)
 Record these contracts on our balance sheet
 DAY WE ENTER CONTRACT  DR Receivable from broker 12,500 CAD
CR. Payable to broker 12,500 CAD
 All subsequent periods are recorded at FV (at Y/E revalued)
DR. Loss on FV of financial instrument x
CR. Receivable from broker x
*** x = difference caused between exchange rates
 Any gain or loss must go through net income
 This gain or loss will go on income statement
 We must adjust the receivable on the balance sheet as well and create a liability for the
difference

 Hedging PURPOSE
 If we buy the contract to pay off liability, not to make profit
DR. Purchases 12,500 CAD
CR. A/P 12,500 CAD
  When we revalue
DR. A/P 200 CAD
CR. Foreign currency gain 200 CAD
 This will net out on the income statement showing zero (ZERO RISK)
 No special accounting is required to show the net effect of this
 The gains and losses on income statement show reader the risk

 What happens if as soon as we order these goods, we make a contract with the broker
but the goods only arrive in the next year?
 The contract is there but the payable is not on our books yet
 The difference in timing and value will not offset one another and it will appear that the
company lost money
 This is a mismatch
 Occurs when the hedge (contract) is not in the same period as the item it is hedging
 This is the only time when we require special accounting
 GAAP allows this “hedge accounting”
 Virtually no companies will use it because it is extremely sophisticated
 Can be hedging without using hedge accounting
 Hedge accounting says that if we have this mismatch, the loss will NOT go through net
income and instead we will push the loss and defer it
 Will defer it to when we receive the item and will restate it to the next year
 The loss will go to other comprehensive income initially and when we restate it will be
moved to net income
 This is called cash flow hedging (the movement from OCI to NI)
 Not all companies are ALLOWED do it

CONSOLIDATION WITH DIFF FUNCTIONAL CURRENCIES !!!!!!!

 CHP 7 METHOD 1
 CHP 8 METHOD 2
 Foreign Currency Translation
 Financial statements should be presented from the perspective of a functional currency
 We are showing the reader the related risk through net income (foreign currency gains
and losses)
 We are ALLOWED to present our FS in any currency we want
 BUT in consolidation we must have a common presentation format
 Must have a methodology to TRANSLATE these FS form their functional currency to their
translation currency
 Three Types of Currency
1. Recording currency (transaction currency)
2. Functional currency
3. Presentation currency
 If we were not recording with functional currency, this would cause gains and losses
 Must identify where the foreign currency risk lies, at which level
 All currencies must yield the same ratios at YE on the FS, presentation and functional
when converted to one another
 We must ensure through this conversion and consolidation that there are NO
differences
 Gains and losses are measured from diff between recording currency and functional
currency

EXAMPLE:
Company A uses CAD in their books as well as their functional currency
It will present consolidated statements in CAD
Here, we are measuring the foreign currency risk at the CAD level
but functional AND presentation currency are the same so no risk?

EXAMPLE 2:
Company B is a subsidiary of Company A. They record all transactions in USD with that
as their functional currency too. BUT must present in CAD at consolidation.
Here, their foreign currency risk is at the USD level, anything NOT in the USD presents a
foreign currency risk

EXAMPLE 3:
Company C is a subsidiary of Company A. They record transactions in USD with their
functional currency being CAD. Their presentation currency is also in CAD
Here, their foreign currency risk is at the CAD level. Their primary economic activity
takes place CAD but they record it all in USD, so the translation form USD to CAD causes
the gains and losses (risk)

Types of Translation Methods

 1. Temporal method (from recording to functional currency)
 2. Current rate method (from functional to presentation currency)

EXAMPLE 4:
Company D uses a transaction currency is USD, functional currency is EURO and the
presentation currency is CAD. This will require 2 translations form recording to
functional then functional to presentation currency. This will cause two different types
translation methods to be used.

 Current Rate Method

 In order to go from USD to CAD (functional currency to presentation currency), what
rate should we use to translate the USD statement to CAD statement?
 This would be for ASSETS, LIABILITIES, AND EQUITY
 Ensure to use the same rate as every line item
 Most often will be the dec. 31st Y/E rate
 This scenario causes a risk for the difference in rates (causes gains and losses)
 Another risk is when the investment gets sold (triggers gains and losses)
 To fix this issue, the equity section gets multiplied by the historical rate (the rate when
the transaction originally happened)
 BUT how do we balance????????? (between YE rate and historical rate)

cumulative translation = ∆ NA x ∆ HR – CR

 The change in the rates multiplied by the asset/liabilities value

 Where does this cumulative translation gain or loss go on the statements? A separate
line in COCI
 This item is recycled meaning that if it was to be sold it would be counted as part of the
gain or the loss on the item, then go through net income and eventually in retained
earnings

EX: Company B must translate from USD to CAD

They have sales, accounts payable and net income
They must translate function to presentation using the average rate for the year

 Could be that the balance sheet and income statement use a different rate
 OCI will hold the translate gain/loss amount
 It is the current rate at a specific date but as time passes it becomes the historical rate

 In order to go from functional to presentation currency we use the CURRENT RATE

METHOD
 To go from transaction currency to functional currency we must use the TEMPORAL
METHOD
 Functional currency is determined by primary economic activities
 These economic activities are determined by primary and secondary indicators
 Usually function and presentation currency are the same
 EXCEPTION: will not have the same functional and presentation currency when the
sub/associate is part of a group
 If the subsidiary determines its own functional currency, they must have additional
factors to determine what their primary economic activity is
 Anything NOT in functional currency is a foreign currency transaction
 These transactions cause RISK
 These transactions are initially recorded at spot rate
 If these transactions were monetary they were RESTATED at Y/E
 These restatements would cause gain or losses in net income
 THESE ADDITIONAL FACTORS INCLUDE
- Intragroup transactions (do they transact often? Or does sub operate completely on its
own?)
- Management (where are decisions being made?)
- Day to day financing (does parent provide sub all funding?)
- Technology (who handles any technological decisions?)

EX: Parent CAD & Sub USD

 If there are a lot of intragroup transactions, it points to the CAD$ as the functional
currency since this is where the risk is primarily reflected
 Primary economic activity is happening in CAD

 TEMPORAL METHOD must translate statement in a manner that will reflect risks
BALANCE SHEET
 We must take every asset and liability (if monetary) at the current rate
 We must take every asset and liability (if monetary) at the historical rate
 We are showing that the monetary items that are causing the risk through this set up
 Equity stays at historical rate
 BUT assets, liabilities and equity does not balance here
 THEREFORE, IN ORDER TO BALANCE, must have a line item to account for the difference
which is the TRANSLATION GAIN/LOSS

CUMULATIVE TRANSLATION GAIN/LOSS ∆ Monetary NA x ∆ FC Rates

 This amount will go under equity

 Under retained earnings?
INCOME STATEMENT
 We must look at balance sheet and whether it is monetary or not
 If monetary = current rate and if non-monetary = historical rate
 We must take the sales and compare to A/R and cash, both of monetary so we use
current rate (which is the average rate)
 We must take COGS and compare to BEG INV + PURCH – END INV
 BEG INV = non-monetary so Historical rate
 Purchases (cash & A/P) = monetary so current rate
 END INV = non-monetary so historical rate
 Most expenses are monetary since they deal with A/P, accrued liabilities and cash
 EXCEPTION = depreciation/amortization expense are NON-monetary so historical rate

ASPE
 If there is no mention usually assumes that the functional currency is CAD
 ASPE states that we can have a parent with multiples subs and associates that need to
be associated
 Once again we must make sure consolidated statements properly reflect risk
 Subsidiaries can be either 1. Self-sustaining OR 2. Integrated
 ASPE says a parent must determine which their subs categorize under
 CRITERIA is the same as IFRS except there is NO RANKING
 Ranking meaning primary, secondary and additional
 Self-sustaining would point to the subsidiaries functional currency (LOCAL CURRENCY)
 Integrated would point to the parent’s functional currency
 Self-sustaining = current rate method
 Integrated = Temporal method
 **ISSUE: ASPE doesn’t have COCI or OCI, so we must put the difference of translation in
Equity as a separate line for the Current Rate method (CUMULATIVE TRANSLATION)
 We put the difference o f translation in R/E for the Temporal Method