Respond to the following: a. What does the term functional currency mean? b. What is the accounting treatment if the foreign entity’s currency in the functional currency? c. What is the accounting treatment if the U.S. currency is the functional currency?

Question

What will be an ideal response?

Answer 1

ANSWER:
a. The functional currency is the currency of the subsidiary’s primary economic environment where cash is primarily received and spent.

b. If the foreign entity’s currency is the functional currency, net income is measured in the foreign currency and then restated into dollars at the average exchange rate for the period. All balance sheet items are translated at the current exchange rate at the end of the period. Any exchange adjustment resulting from translating balance sheet and income statement items at different exchange rates is displayed as a separate component of stockholders’ equity, not as a gain or loss on the income statement.

c. If the functional currency of a foreign operation is judged to be U.S. dollars, the accounting records must be converted into U.S. dollars. This is called remeasurement and is done by following the temporal approach of SFAS No. 8.

With this approach, all balance sheet items that were carried at current or future exchange prices are translated at the current exchange rate, while items carried at past prices are translated at exchange rates existing at the time the item was acquired. Income statement items are translated at the average exchange rate for the reporting period—except that items related to balance sheet accounts that were translated at historical exchange rates, such as cost of goods sold and depreciation, are also translated at the historical rates. Exchange gains and losses arising from translation from the currency of record into the functional currency would be recognized on the income statement.