Respond to the following: a. What are the six guidelines that SFAS No. 52 provides for determining the functional currency? b. What were the findings of the FASB research report by Evan and Doupnik regarding these six criteria?

Question

What will be an ideal response?

Answer 1

ANSWER:
a. The six guidelines that SFAS No. 52 provides for determining the functional currency are as follows:
(1) Cash flow indicators
a. Foreign Currency—Cash flows related to the foreign entity’s individual assets and liabilities are primarily in the foreign currency and do not directly impact the parent company’s cash flows.
b. Parent’s Currency—Cash flows related to the foreign entity’s individual assets and liabilities directly impact the parent’s cash flows on a current basis and are readily available for remittance to the parent company.
(2) Sales price indicators
a. Foreign Currency—Sales prices for the foreign entity’s products are not primarily responsive on a short-term basis to changes in exchange rates but are determined more by local competition or local government regulation.
b. Parent’s Currency—Sales prices for the foreign entity’s products are primarily responsive on a short-term basis to changes in exchange rates; for example, sales prices are determined more by worldwide competition or by international prices.
(3) Sales market indicators
a. Foreign Currency—There is an active local sales market for the foreign entity’s products, although there also might be significant amounts of exports.
b. Parent’s Currency—The sales market is mostly in the parent’s country or sales contracts are denominated in the parent’s currency.
(4) Expense indicators
a. Foreign Currency—Labor, materials, and other costs for the foreign entity’s products or services are primarily local costs, even though there also might be imports from other countries.
b. Parent’s Currency—Labor, materials, and other costs for the foreign entity’s products or services, on a continuing basis, are primarily costs for components obtained from the country in which the parent company is located.
(5) Financing indicators
a. Foreign Currency—Financing is primarily denominated in foreign currency, and funds generated by the foreign entity’s operations are sufficient to service existing and normally expected debt obligations.
b. Parent’s Currency—Financing is primarily from the parent or other dollar-denominated obligations, or funds generated by the foreign entity’s operations are not sufficient to service existing and normally expected debt obligations without the infusion of additional funds from the parent company. Infusion of additional funds from the parent company for expansion is not a factor, provided funds generated by the foreign entity’s expanded operations are expected to be sufficient to service that additional financing.
(6) Intercompany transactions and arrangements indicators
a. Foreign Currency—There is a low volume of intercompany transactions and there is not an extensive interrelationship between the operations of the foreign entity and the parent company. However, the foreign entity’s operations may rely on the parent’s or affiliates’ competitive advantages, such as patents and trademarks.
b. Parent’s Currency—There is a high volume of intercompany transactions and there is an extensive interrelationship between the operations of the foreign entity and the parent company. Additionally, the parent’s currency generally would be the functional currency if the foreign entity is a device or shell corporation for holding investments, obligations, intangible assets, etc., that could readily be carried on the parent’s or an affiliate’s books.

b. The FASB research report by Evans and Doupnik found that the six criteria provided adequate guidance for determining the functional currency. Furthermore, the respondents to the study agreed very strongly that the standard works well. Of the six indicators, the four that were most heavily weighted were the first four listed above. Only a small percentage of the participants had difficulty in determining the functional currency in many cases.