Conversion of financial statements to foreign currency

CONVERSION CONCEPT

The concept of "conversion" implies transforming, re-expressing or transferring the financial statements originally prepared in one currency "A", in another currency "B".

A conversion is a monetary restatement in which:

• The object (what is expressed) is a measurement in the currency of origin; The product is a measurement (equivalent to the previous one) in a conversion currency; The second measurement is obtained from the first and some type of exchange that indicates the number of units in the source currency for which a unit of the conversion currency can be exchanged, or vice versa.

When what is converted is the data set that makes up a set of financial statements, we are talking about conversion of financial statements.

AIM OF THE CONVERSION

Fowler Newton establishes that isolated data conversions are essential when in an accounting carried out in one currency, the effects of purchases, sales, payments and collections in other currencies must be recognized; and the effects of changes in the values ​​of assets and liabilities in those currencies. Conversion is also necessary when you want to keep accounting in more than one currency.

With regard to financial statements, the conversion of these to another currency may serve the following purposes:

a) Obtain information for decision-making in a currency other than the local currency;

b) provide information to foreign shareholders who are more comfortable using data expressed in the currency of their own country or in another of universal use;

c) so that a company that prepares financial statements in another currency and owns shares of the issuer of the financial statements can consolidate or combine the financial statements of the issuer or apply the Proportional Equity Value method.

CONVERSION AND COMPREHENSIVE ADJUSTMENT FOR INFLATION

Both the conversions and the comprehensive adjustments for inflation imply monetary restatements, but in the former, the replacement of one measurement by another is due to the exchange rate of one country's currency for that of another; and in the latter to the consideration of changes in the purchasing power of a given currency.

The conversion of financial statements cannot replace the adjustment for inflation because:

- Virtually no currency is exempt from inflation;

- Although the conversion currency is affected by a relatively low inflation rate, it has a significant cumulative effect and can significantly affect the indicators that measure profitability;

- Data in foreign currency is rarely accepted by law as the basis for corporate decision-making;

- The inflation that affects a source currency does not have to behave in the same way as the exchange rate between it and the chosen conversion currency.

Therefore, it is necessary to combine the conversions with the adjustments for inflation, for which two basic approaches have been proposed:

A) Convert / Adjust:

1) replace the measurement in the currency of origin with another in the currency of conversion, using the corresponding exchange rate;

2) adjust for inflation the measurement in the currency of conversion, considering the changes in its purchasing power;

B) Adjust / Convert:

1) First, the measurements in the currency of origin are adjusted so that they remain in the currency of the date of the accounting report to be prepared;

2) the adjusted amounts are then converted into the conversion currency using an exchange rate on the date of the accounting report.

EXCHANGE RATES TO USE

For data conversions in another currency

The main operations expressed in foreign currency that must be converted into national currency are:

• Those that generate credits and debts (sales and loans made, purchases and loans received).

The exchange rate to be used should be the one corresponding to the moment (or period) of accrual of the transaction. In general, it is necessary to determine:

- If the subsequent cancellation of the credit (or debt) will be made in the foreign currency itself (receiving or delivering banknotes) or in national currency (through a financial entity);

- In case of differential exchange rates, what is applicable;

- If, according to the characteristics of the operation, a buyer or seller exchange rate must be considered.

• Those that cancel credits and debts.

Payments in foreign currency for cash purchases or to pay debts should be converted at the exchange rate at which the delivered currencies could have been settled (on the date of the transaction).

Collections in foreign currency for cash sales or for collections of credits in foreign currency should be converted at the exchange rate at which the currencies received could be settled (on the transaction date).

For revaluations of balances, the exchange rates corresponding to the date of the new accounting measurement should be considered.

For data conversions to another currency

There is agreement that for these conversions the exchange rate corresponding to the market used to pay dividends is used. This takes into account the point of view of foreign investors, who are the persons in whose interest conversions of financial statements are usually made.

On the other hand, the exchange rate to be used should be that of the date in which the measurement in the currency of origin is expressed in purchasing power, since the conversion should only point to the change in the unit of measurement. Therefore, before any conversion, the effects of inflation adjustments that have affected measurements in the currency to be converted should be excluded.

As in the inflation adjustment, special care must be taken with the items in the currency of origin that result from comparing two or more measurements expressed in different defined purchasing power, such as those corresponding to holding results (financial and others). In these cases, what must be done is: a) convert each of the compared measurements; b) redo the comparison using the converted measurements.

Cases where markets are not free

It is possible that the prices of foreign currencies do not arise from the free play of supply and demand, but from government resolutions or when the State intervenes by buying and selling foreign currency in sufficient quantity to affect exchange rates.

These situations raise doubts about the suitability of market quotes as a basis for long-term balance conversions. These possible approaches should be studied:

- If there is an official and a parallel market, base the accounting valuations on the prices of the second;

- Do not use any price but some equilibrium parity or some theoretical parity;

- Apply the traditional accounting criteria of using the market exchange rates (official or free, as the case may be).

Parallel quotes: their employment has not been accepted, in part because they may not be representative since the market operates underground and in turn, due to the volume of currency traded (sometimes very low).

Equilibrium parities: implies the use of a conventional exchange rate, which deviates from the official exchange rate at closing.

Theoretical parities.

Its use is difficult to defend, among other things because:

- The calculations depend on the moment chosen as the base;

- Debts are paid and credits are collected according to the real exchange rates in force on the date of its cancellation;

- The evolution of real exchange rates does not depend exclusively on the inflations (local and foreign) that constitute the basis for calculating theoretical parities.

CONVERSION METHODS OF FINANCIAL STATEMENTS TO FOREIGN CURRENCY

The United States has been characterized for being the ones that have historically had the most investments abroad, and this is manifested in that they have been the first to deal with this issue.

a) Evolution of the conversion method over time:

Of the different conversion methods developed below, the first three are only of value as a doctrinal antecedent.

They are:

1) Close exchange rate method: where all accounts were converted at the closing exchange rate, without distinguishing whether they were current or non-current.

2) The current and non-current method: originated in the American pronouncement ARB 43, by which all current accounts were converted at the closing exchange rate and non-current ones were translated into foreign currency based on the exchange rate originally. Most items in the Income Statement are translated at the average exchange rate for the period, except depreciation, which is translated at the exchange rate of origin, in order to maintain consistency with the non-current item that originates it. This method was used until 1975.

3) Monetary and non-monetary method : represents an advance over the previous method, because it no longer disaggregates based on the account's classification, but rather on the nature of the account, in monetary and non-monetary. The monetary accounts that show closing purchasing power are converted at the closing exchange rate and the non-monetary ones at the original exchange rate. The treatment for the Income Statement accounts is identical to the previous method. The main obstacle to this method is the use of Current Values, since non-monetary accounts would also be at closing purchasing power.

4) FAS 8: where from 1976 the Temporary Method is adopted, which we will develop later.

5) FAS 52: it replaces FAS 8, from 1981, and considering two Conversion Methods: the Temporary Method and the Translation Method. The main criticisms made of FAS 8 were: that the Conversion Result was always reflected in the Income Statement; changes when converting accounts could be confusing regarding operating performance, showing operating losses, even during profitable years; it produces various fluctuations in results over which managers have no control.

6) IAS 21: prepared by the IASC, which generally follows FAS 52, but incorporates a variant in the case of hyperinflationary economies.

7) SSAP 20: prepared by the ASB, an integral part of the FRC (Financial Reporting Council) of England and Wales, which broadly adopts the solutions of FAS 52 and IAS 21.

b) The Temporary Method:

1) Concept of Conversion:

It consists of converting the Financial Statements of currency from one country to another, as if all the operations that occurred in the original currency had occurred in the currency of conversion, in the country of origin. Therefore, it maintains the Generally Accepted Accounting Principles with which the Financial Statements in the currency of origin were prepared.

What this method proposes is a restatement of the Financial Statements, it is a “re-measurement” in foreign currency (we are changing the unit of measurement), and it consists of rethinking the Financial Statements in foreign currency.

What it seeks is to measure the equity situation and the results in foreign currency, consequently, the Financial Statements must be those that would be obtained if the accounting were carried out in that foreign currency to which it wants to convert.

How is this restatement accomplished? There are two possibilities, the first is to keep a parallel accounting in foreign currency, and the second is to apply the Temporary Method.

2) Fundamental Concepts:

Conversion method:

Applying the Temporary Method implies converting the Financial Statements in local currency, according to the following guidelines:

• Accounts carried at past exchange prices are converted using historical exchange rates, corresponding to the times when the respective prices were established (date of operation). Accounts carried at current purchase or sale prices or of future exchanges, they must be converted at the current exchange rate (at the closing date). In addition, the Cost - Minor Market Rule must be applied to the converted accounts.

The aforementioned implies:

• Convert monetary items at the closing exchange rate. Convert non-monetary items depending on the valuation criteria:

a) If they are valued at cost, using historical exchange rates, or what is the same, the exchange rate at the time the asset entered the company.

b) If they are valued at current values, the closing exchange rate or that corresponding to the date on which that value was determined must be used.

• Income accounts are converted at the exchange rate of each transaction, except those derived from asset accounts (eg, cost of sales, depreciation, etc.) that must follow the same treatment as the asset that gave rise to them., in order to maintain the consistency of the adjustment method.

3) The Conversion Process:

To convert Financial Statements to Foreign Currency, applying the Temporary Method, the following steps must be followed:

1. Convert the Financial Statements at the beginning, re-expressing the assets and liabilities at the corresponding exchange rate, as explained in the previous point. The contributions made by the partners are restated, at the exchange rate of the contribution date, and by difference, the results accumulated in foreign currency at the beginning are determined.

2. Convert the Financial Statements at the close, restating the assets and liabilities applying the same methodology applied for the Financial Statements at the beginning. To the contributions made by the partners, prior to this financial year, already restated at the exchange rate of the contribution, the new contributions are added (only the actual contributions are considered). To the Accumulated Results already restated at the beginning, the actual distributions made are subtracted, and by difference, the Result of the Exercise is determined.

3. The income statements are restated at the exchange rate of the transaction, except those derived from asset accounts, which will follow the same treatment as the asset that gave rise to them. And by difference, we obtain the Conversion Result.

4. Verify the Conversion Result obtained by difference, which is verified in a similar way as the RDM of the inflation adjustment.

In the Temporary Method, the Translation Result is a result generated by the holding of monetary assets and liabilities in local currency due to the variation in the price of the conversion currency.

In this method, the Exchange Difference once the Financial Statements are converted, is the one generated by the possession of a third currency (that is not the local currency or the conversion currency.) No exchange difference can be generated by holding the currency of conversion.

c) The Translation Method or Functional Currency

This method arises with FAS 52 and is included in IAS 21.

This FASB pronouncement is applicable when conversions are used to:

• Consolidation Combination Equity Equity

When the objective is different, it will be determined by those interested in the conversion of the Financial Statements.

1) Concept of Conversion:

The Translation Method involves measuring the Financial Statements not in the currency of conversion, but in the currency in which the company works, which FAS 52 calls Functional Currency.

The functional currency of an entity is the currency of the main economic environment in which the entity operates; normally, it is the currency of the system in which the entity initially generates and uses funds.

Once the Financial Statements have been measured in functional currency, they are taken into the conversion currency, making a translation, not a restatement.

The Translation Method considers the translation of the Financial Statements from the investor's point of view, it aims to measure the results of the investment abroad based on the effect it has on the investor's cash flows, that is, those results that affect the ability to draw funds or dividends to the parent; as if the company that converts the Financial Statements is an indivisible unit, which the investor owns or sells as a whole.

This method is not applicable to economies whose inflation rate accumulated in the last 3 years is 100% or more (hyperinflationary economy), since its currency is not considered stable enough to be used as a functional currency, and must be used instead. the most stable currency. This implies, under FAS 52, using the Temporary Method for hyperinflationary economies.

IAS 21 coincides with FAS 52 in the objective criterion for the definition of hyperinflationary economy, but it proposes a different method of conversion, which we will develop later.

2) Fundamental Concepts:

a) Functional Currency:

The Translation Method involves measuring the Financial Statements in the functional currency, and then converting them, for this we must determine which is the Functional Currency.

Once we determine the functional currency, it must be used consistently, unless there are significant variations in facts or economic circumstances that clearly indicate that the functional currency has changed.

The main economic factors represented below, and possibly others, must be considered both individually and collectively in determining the functional currency. Compliance with only one of these factors is not enough to define which is the functional currency of a company; the analysis must be joint and simultaneous.

Cash Flow Indicators

• Local Currency - The cash flows related to the individual assets and liabilities of the branch or subsidiary are mainly in foreign currency and do not have a direct impact on the cash flows of the parent. Parent Currency - The cash flows related to the individual assets and liabilities of the branch or subsidiary have a direct impact on the parent company's current cash flows and are readily available for shipment to the parent.

Sale Price Indicators

• Local Currency - The sales prices of the products of the branch or subsidiary do not react in the short term to changes in the exchange rate, but are mainly determined by local competition or by regulation of the local government. sale of the products of the branch or subsidiary react in the short term to changes in exchange rates; for example, sales prices are determined by world competition or by international prices.

Sales Market Indicators

• Local Currency - There is an active local sales market for the products of the branch or subsidiary, although there may also be significant amounts of exports. Parent Currency - The sales market is mainly the country of the parent or sales contracts they are denominated in the parent currency.

Expense Indicators

• Local Currency - The costs of labor, materials and other costs of the products or services of the branch or subsidiary are mainly local costs, even if there are imports from other countries. Matrix Currency - The costs of labor and other costs of the products and services of the branch or subsidiary, on a continuous basis, are mainly costs of components obtained from the country in which the parent company is located.

Financing Indicators

• Local Currency - Financing is mainly denominated in foreign currency, and the funds generated by the operations of the branch or subsidiary are sufficient to pay the existing and normally expected debts. Parent Currency - Financing is done mainly by the parent or other commitments are denominated in dollars or the funds generated by the operations of the branch or subsidiary will not be sufficient to pay the existing or normally expected debts, without the injection of additional funds by the parent. The injection of additional funds from the parent for expansion purposes does not count as a factor, if the funds generated by the expansion of the operations of the branch or subsidiary were sufficient to attend to that additional financing.

Indicators of transactions and intercompany agreements

• Local Currency - There is a small volume of international transactions and there is no great interrelation between the operations of the branch or subsidiary and the parent. However, branch or subsidiary operations can rely on the advantages that the parent or its associates offer over the competition, such as patents and trademarks. Parent Currency - There is a high volume of intercompany transactions and there is a high interrelation between the operations of the branch or subsidiary and the parent. In addition to this, the parent currency is generally the functional currency when the branch or subsidiary is an auxiliary instrument or company intended to possess investments, obligations, intangible assets, etc., which could be easily accounted for in the parent's books or from an associate. ”

b) Conversion Method:

Applying the Translation Method implies completing the following steps:

i) Determine the functional currency of the investment abroad.

ii) “Remedy” the Financial Statements of the currency in which they are prepared (generally in local currency) into functional currency. - Temporary method.

iii) Convert the Financial Statements from the functional currency to the conversion currency (parent currency). - Translation method.

The 1st step, we have already developed by defining the concept of Functional Currency and the economic factors that must be considered for its determination.

The 2nd step (according to FAS 52) must be carried out as if each and every one of the company's operations was carried out in functional currency, this is what we previously defined as the Temporary Method.

In the event that the local currency coincides with the functional currency, this step must be skipped.

The 3rd step is to apply the Translation Method, which is a combination of the Temporary Method with the Close Exchange Rate Method. With this method we must apply the following guidelines:

• Assets and Liabilities are converted at the exchange rate on the date of the conversion (normally, it is the closing exchange rate). In Equity, the contributions made by the partners (as in the Temporary Method), are converted at the exchange rate on the date of the contributions, with the intention of taking into account the amount contributed by the parent in its currency, and keeping the amount invested fixed. Concomitantly another account will appear, called Translation Adjustment, which receives the treatment of a reservation, it is not considered a result, because the objective of the Translation Method is to measure the results of the investment abroad, depending on the effect it has on the investor's cash flows, that is, those results that affect the parent's ability to draw funds or dividends.The Translation Adjustment is the consequence of having an investment in a currency that is not the parent currency and that is not a result that can be turned to the parent (the investment is the company, it does not refer to the holding of assets and liabilities in other currencies). This result may be distributed on the occasion of the partial or total liquidation of the company that translates the financial statements according to this model. At that time, it will be a loss or profit for the investment company, since they will have an effect on the cash flows, and that is when the investment company receives the result of its investment.This result may be distributed on the occasion of the partial or total liquidation of the company that translates the financial statements according to this model. At that time, it will be a loss or profit for the investment company, since they will have an effect on the cash flows, and that is when the investment company receives the result of its investment.This result may be distributed on the occasion of the partial or total liquidation of the company that translates the financial statements according to this model. At that time, it will be a loss or profit for the investment company, since they will have an effect on the cash flows, and that is when the investment company receives the result of its investment.

3) The Conversion Process

To apply the Translation Method (go from functional currency to conversion currency), we must apply the following steps:

1) Transfer the Financial Statements at the beginning in functional currency to the conversion currency, for which the assets and liabilities are converted at the beginning, at the initial exchange rate (which is the exchange rate at the end of the previous year). The contributions made by the partners, at the historical exchange rate, and by difference we determine the accumulated results in the conversion currency at the beginning; These accumulated results are made up of: Accumulated Results plus Translation Adjustments from previous years (including the one corresponding to the Financial Statement that we took as initial to apply the method).

2) Transfer the Financial Statements at closing in functional currency to the conversion currency, for this purpose assets and liabilities at closing are converted at the closing exchange rate. The contributions made by the partners will be the same that were converted at the beginning plus any contribution made in the year, converted at the exchange rate on the day of the contribution. The accumulated results will be the same as at the beginning, less the real distributions, converted at the exchange rate on the date of distribution. We go to the Income Statement, where we convert all the results at the exchange rate on the accrual date thereof, and calculate the Results for the Year. Calculated the same, we return to the State of Patrimonial Situation and we place it in the converted Patrimony, and by difference the Translation Adjustment is obtained,which is considered as Equity and not as Result.

3) We verify the Adjustment by Translation.

d) SSAP 20:

Regarding the Conversion of Financial Statements, SSAP 20 classifies operations in foreign currency as follows:

• An entity can carry out transactions that are denominated in foreign currency, the results of those transactions must be translated into the currency in which the company prepares its Financial Statements. An entity can make investments in other economies or economic environments through branches. or subsidiaries, which maintain their accounting records in a currency other than that of the parent company. To prepare the Consolidated Financial Statements, it will be necessary to convert the Financial Statements of the subsidiaries to the currency of the parent company.

The conversion of operations in foreign currency and of the Financial Statements produces results that are generally compatible with the effects of a variation in the exchange rate in the cash flows and in the net equity.

This pronouncement will provide procedures to be adopted when:

• Post foreign currency transactions Consolidated Financial Statements are prepared.

The method used to convert Financial Statements for consolidation purposes must reflect the financial and operating relationships that exist between the investment company and its subsidiaries (paragraph 13). In addition, the conversion methods and the net gains and losses from the variation in the exchange rate that are generated must be disclosed in Notes to the Financial Statements, separately identifying the amount that was carried to reserves and the net amount carried to results.

Close Exchange Rate / Net Investment Method : This method establishes that a company's investment is the net worth of the foreign company and not a direct investment in assets and liabilities considered individually. The subsidiary will normally have assets that must be financed in part with loans in local currency. The daily operations of the subsidiary are not normally expressed in the currency in which it is reported.

The investing company is more interested in cash flow than in net investment, this is until the business is liquidated or set aside.

In this method, the amounts in the balance sheets of a foreign entity must be converted to the reporting currency using the closing exchange rate.

Profits and losses must be converted at the closing exchange rate or the average exchange rate for the period. The use of both methods is allowed, but said use must be carried out consistently from one period to another. When the average exchange rate used differs from the closing exchange rate, the difference that arises must be taken to a reserve account within equity.

This method is generally related to the Translation Method.

Temporary Method: In cases where the relationship of a foreign company (subsidiary) is so closely linked with the investor, its results should be regarded as an extension of the investment company. The Financial Statements of the subsidiary must be included in the consolidated Financial Statements as if all the operations had been carried out by the investing company in its own currency. This is the Temporary Method.

To determine when the currency of the investment company is the dominant one in the economic environment in which the subsidiary operates, the following factors must be taken into account:

• The operations of the subsidiary have an impact on the cash flows of the investment company. The operations of the subsidiary depend directly on the investment company. Most of the transactions carried out by the subsidiary are expressed in the currency of the investment company. The subsidiary's financial structure is mainly in the currency of the investment company.

In these cases, the translation result goes directly to the Income Statement for the period.

Branches abroad must be converted according to the nature of the business operations, that is, according to one of the two methods described above.

Later and together, we will see the treatment in hyperinflationary economies.

SSAP 20 began to be applied for the exercises started on April 1, 1983, currently it has been replaced by FRED 24 (Financial Reports Standards) “The Effects of Changes in Foreign Exchange Rates & Hyperinflationary Economics” that converges towards the NIC twenty-one.

Comparative Table of the different Conversion Methods

Conceptual Bases of the Temporary Method and the Translation Method

The Temporary Method respects the principle of a homogeneous unit of measure, re-expresses the Financial Statements, performs a "re-measurement" of them, changing to another unit of measure, to another currency.

If we are converting the Financial Statements of a subsidiary, with the aim of consolidating, and knowing that to consolidate we must express everything in a homogeneous unit of measurement, we apply the Temporary Method, since it is the method that the unit of measurement respects.

The Temporary Method assumes that only monetary assets and liabilities are exposed to devaluation, and recognizes as a realized result the effect of having such items (Translation Result).

The Translation Method has as its main objective to represent the economic reality, the unit of measurement is important, but it is no longer the priority, since the investor wants to know what the results were and what effect it will have on his flow of funds, he wants to know those results that affect the ability to draw funds or dividends to the parent. Therefore, this method measures the results and the situation in the currency that the subsidiary works (functional currency) and then transfers those balances to the conversion currency.

The Translation Method assumes that all the investment (assets less liabilities) is exposed to devaluation, and recognizes the effect of the devaluation on the total investment; This effect is due to the holding of an investment in a currency different from that of the report, which does not generate a flow of funds and is not a realized result, but rather a difference in the valuation of the investment, which is included in equity. (Adjustment by Translation). This adjustment will be a realized result, at the time the parent sells the subsidiary.

THE CONVERSION OF FINANCIAL STATEMENTS TO FOREIGN CURRENCY ACCORDING TO APPROPRIATE FINANCIAL STANDARDS IN URUGUAY.

According to Adequate Accounting Standards in Uruguay, we must apply IAS 21 to convert Financial Statements to Foreign Currency.

In general, IAS 21 coincides with FAS 52, but it differs in the treatment in the case of hyperinflationary economies (IAS 29 defines hyperinflationary economy, as one where the accumulated inflation of the last three years exceeds 100%).

IAS 21 does not distinguish between functional currency, local currency and conversion currency, but it establishes two categories of companies: Foreign Operations integrated into the parent and Foreign Entities not integrated into the parent.

Just as FAS 52 establishes criteria to determine the functional currency, IAS 21 does so to determine if a company is a Foreign Entity.

General

First of all, it is necessary to clarify that this pronouncement refers to the conversion of financial statements only for the purposes of consolidation, applying the proportional equity value method or accounting for transactions in foreign currency. The current revision of the standard was approved in December 1993 and is effective for the financial statements corresponding to years beginning on or after December 1, 1995.

Classification of foreign operations

The norm is in charge of establishing a differentiation of investments abroad according to their operational characteristics:

Integrated foreign operations

The subsidiary carries out its operations as if they were an extension of the parent. A clarifying example would be the case of an industrial plant installed abroad that receives the main inputs from the matrix and then returns the finished product. The raison d'être of this subsidiary would be the reduction of costs, cheap labor, for example, not constituting a business unit in itself.

It should be noted that in these cases the variation in the exchange rate between the currencies would have an immediate effect on the present and future cash flows of the parent, so that the monetary assets and liabilities of the subsidiary will be individually affected by said variation..

Foreign Entity (Foreign operations not integrated or with relative autonomy)

In these cases, the subsidiary carries out its operations independently of the parent, accumulating cash, incurring expenses, generating income and contracting loans mainly in local currency. The variation in the exchange rate will no longer have almost any impact on the present and future cash flows as we saw in the integrated foreign operations, but will directly affect the parent company's net investment abroad.

As a complement, paragraph 26 of the rule establishes a set of circumstances that can serve as a guide to determine if a business abroad is a foreign entity:

- The activities of the subsidiary are carried out with a considerable degree of autonomy with respect to the parent

- The transactions between the parent and the subsidiary do not represent a significant proportion of the total transactions of the subsidiary

- The subsidiary is financed with funds from its operations or with local loans

- The costs of labor, materials and others associated with products and services are settled in local currency.

- Sales of the subsidiary are mainly made in local currency

- The daily activities of the subsidiary do not affect the generation of cash flows from the parent

If these circumstances did not arise, we would be facing an integrated foreign operation.

The correct classification will depend on the specific information that is available linked to the aforementioned indicators, as well as the appropriate professional judgment, in cases that do not provide sufficient clarity.

Conversion process

Initial investment recognition

The first step for the conversion involves, regardless of the type of business in question according to the previous classification, that the initial investment be converted by applying to the monetary amount invested the exchange rate of the date of the transaction.

Conversion of the financial statements

Conversion here takes different directions depending on whether it is an integrated foreign operation or a foreign entity, differentiating here whether it operates in a hyperinflationary context or not.

a) Integrated foreign operation

In this case, it is assumed that the items to be converted must be expressed as if they had originally originated in the reporting currency. In this way, the financial statements will be converted using the temporary method. This implies that monetary items are converted at the closing exchange rate, while the treatment for non-monetary items will depend on whether they are valued at historical cost or at fair values ​​(current value). In the first case they will be converted at the exchange rate of the transaction date, in the second case they will be converted at the exchange rate when the fair value is determined.

b) Foreign entity acting in a context without hyperinflation

In this case, it is assumed that the earnings that the parent company will obtain in the reporting currency will be the equivalent of that generated by the subsidiary in local currency, acting in its own economic context and with relative self-sufficiency. In this way, both monetary and non-monetary assets and liabilities will be converted at the closing exchange rate. In turn, income and expenses will be at the exchange rate at the time of the transaction, allowing for practical reasons to adopt average exchange rates.

c) Foreign entity acting in a hyperinflationary context

In this case, the regulation establishes that prior to the conversion of the financial statements, a comprehensive adjustment for inflation is made, applying IAS 29. Then, all items will be converted at the closing exchange rate (assets, liabilities, income and expenses).

IAS 29 includes several subjective criteria to determine whether the economy is in a hyperinflationary context or not, in turn specifying the objective indicator that if 100% inflation was reached in three years, it will always fall in the hyperinflationary context.

In cases where the economy ceases to be hyperinflationary and the foreign entity must consolidate its financial statements, for the purposes of the conversion it must use the amounts expressed in current values, as well as use historical costs.

Treatment of results arising from the conversion process

The results derived from the variation of the exchange rate will be subject to different treatments depending on whether it is an integrated foreign operation or a foreign entity.

a) Integrated foreign operation

In this case, all exchange differences arising from the holding of monetary items will be charged to income for the year in which they take place. As an exception, the exchange differences from monetary items

that are part of the investment of the parent, as well as those that arise from debts incurred to cover it, will be imputed to an equity item until such investment is available.

It is valid to clarify that the norm also proposes an alternative treatment. The same allows exchange differences arising from debts contracted for the acquisition of assets in foreign currency, which have occurred due to a significant devaluation against which it is impossible to cover and which cannot be canceled, are charged to the cost of the acquired asset with the lower limit between replacement cost and recoverable value.

b) Foreign entity

In this case, the exchange differences derived from the conversion process must be imputed in an equity item of the foreign entity. This determines that the result cannot be distributed, unless the sale or the total or partial liquidation of the entity occurs. It can be seen very clearly that in these cases the result arises from the investment itself and not from the holding of monetary assets and liabilities.

APPLICATION OF THE VARIOUS RULES, ACCORDING TO OR NOT IN HYPERINFLATIONARY ECONOMIES

FAS 8 established the Temporary Method as a conversion method under any circumstances.

According to FAS 52, the method to apply varies, depending on the functional currency and the inflationary level of the economy of the country where the subsidiary is located.

a) If the functional currency is equal to the local currency (it works in local currency) there are two alternatives:

• If the economy where the subsidiary is located is hyperinflationary, the currency of an unstable economy cannot be considered as functional, therefore the conversion should always be carried out by the Temporary Method. If there is no hyperinflation in the economy where the subsidiary is located, Go to the conversion currency applying the Translation Method.

b) If the functional currency is the conversion currency: the Temporary Method is applied, since it is the established method to go from local currency to functional currency, and nothing else should be done, because the functional currency is equal to the currency Of conversation.

c) If the functional currency is a third currency: the two methods must be applied, the Temporary Method to go from local currency to functional currency and then the Translation Method to go from functional currency to conversion currency. For example, if the company operates in Uruguay and the functional currency is the dollar and the parent company is in England; Financial Statements in pesos must be converted into dollars by the Temporary Method and then into Pounds by the Translation Method.

FAS 52 in its paragraph 11 defines a highly inflationary (hyperinflationary) economy as one in which inflation reaches approximately 100% or more in a three-year period.

SSAP 20 states that when a foreign entity operates in a highly inflationary economy, it is not possible to express the company's financial position at historical costs simply through conversion. In these circumstances, the Financial Statements in local currency must be adjusted to reflect variations in the price levels of the local currency, before being converted (the same treatment adopted by IAS 21). When this is not possible, the treatment adopted by FAS 52 is allowed, taking the currency of the investing company (that is, the Temporary Method) as the functional currency.

According to IAS 21, the treatment differs depending on whether it is an integrated operation or a foreign entity, and according to the inflationary level of the economy of the country where the foreign entity is located.

a) If it is an integrated operation, the operations of the subsidiary are considered as an extension of the parent, and the Temporary Method is applied. Paralleling the FAS 52, the functional currency is going to be the conversion currency.

b) If it is a foreign entity, there are two alternatives:

• If the economy where the subsidiary is installed is hyperinflationary, the Integral Adjustment for Inflation must be carried out first (IX Inter-American Accounting Conference) and then the Translation Method is applied with the difference that the results are not converted to the exchange rate from the date of accrual but, at the exchange rate of the closing date, because they are already adjusted for inflation at the closing date (they are in a currency of defined purchasing power). If there is no hyperinflation in the economy where the subsidiary is, it is applied the Conversion Method in a similar way to FAS 52.

The different treatments, depending on whether or not they are hyperinflationary economies, can be seen more clearly in the following table:

Bibliography:

1. Bates, David S. - “The Currency Markets” (Material obtained on the Internet) Denis, Eduardo; Horjales, Alejandro; Zabaleta, Daniel - “Conversion of financial statements to foreign currency and their treatment in hyperinflationary economies” Montevideo, 1997. Thesis presented to the Faculty of Economic Sciences and Administration of the University of the Republic.FAS 52 - “Statement of Financial Accounting Satandards No. 52 - Foreign Currency Translation ”. Issued by the Financial Accounting Standards Board (FASB).Fowler Newton, Enrique - “Superior Accounting” Volume II.Hernández Perez Junior, José - “Conversão de demonstracões contábeis para moeda estrangeira: FASB - US GAAP” - 5ª Edição - Editora Atlas. IAS 21 - “International Accounting Standard No. 21 (Revised in 1993) - Effects of variations in foreign currency exchange rates”.Issued by the IASC (currently IASB).Prato, Alvaro; Lucas, Gonzalo - "Consolidation and Methods of Conversion of Financial Statements - Critical Analysis of IAS 21". Material presented at the XVIII CCEE Conference in the Southern Cone. (Mar del Plata 1996). Rodríguez, María del Carmen - “Conversion of Financial Statements”. Material presented at the XVIII CCEE Conference in the Southern Cone. (Mar del Plata 1996).SSAP 20 - “Foreign Currency Translation”. Issued by the Accounting Standards Board (ASB), an integral part of the Federal Reporting Council (FRC).Material presented at the XVIII CCEE Conference in the Southern Cone. (Mar del Plata 1996).SSAP 20 - “Foreign Currency Translation”. Issued by the Accounting Standards Board (ASB), an integral part of the Federal Reporting Council (FRC).Material presented at the XVIII CCEE Conference in the Southern Cone. (Mar del Plata 1996).SSAP 20 - “Foreign Currency Translation”. Issued by the Accounting Standards Board (ASB), an integral part of the Federal Reporting Council (FRC).