# The Impact of Changes in Exchange Rates on the Translated Sales of the Subsidiary and the Parent Company

IFRS and US GAAP require parent companies to prepare consolidated financial statements. Further, IFRS and US GAAP require parent companies to add domestic and foreign subsidiaries operations to their operations. In most cases, a foreign subsidiary operates primarily in the currency of the country where it is located. The local currency may differ from the currency in which the parent company presents its financial statements. To prepare the consolidated financial statements, the parent company must translate the foreign currency financial statements of its foreign subsidiaries into its presentation currency.

#### Example: Effects of Exchange Rate Changes in the Translated Sales of the Subsidiary and the Parent Company

Sanlam is a hypothetical Life and Health Insurance company based in Canada. It keeps its books in Canadian Dollars (CAD). It owns 100% of Sanke, an insurance company based in India. Sanke keeps its books in Indian Rupees (INR). On December 31, 2016, Sanke makes total sales worth INR 500,000 when the exchange rate between the Canadian Dollar and the Indian Rupee (INR) is CAD 0.018 = INR 1.

When translating foreign currency financial statements into the parent company’s presentation currency, it is crucial to address the following: (1) the exchange rate to use in translating each financial statement item, and (2) how is the balance sheet brought back to balance. In this example, we will address the first point, i.e., the exchange rate that Sanlam uses when translating Sanke’s sales.

To prepare a consolidated balance sheet in Canadian Dollars as of December 31, 2016, Sanlam must come up with a translation worksheet as follows:

$$\textbf{Translation Worksheet for Sanke, December 31, 2016}$$

$$\small{\begin{array}{l|c|c|c} {}& \textbf{INR} & \textbf{Exchange Rate (CAD)} & \textbf{CAD}\\ \hline\text{Sales/revenue} & 500,000 & 0.018 & 9,000\\ \end{array}}$$

Therefore, Sanlam will report sales of CAD 9,000 from its subsidiary. When preparing the balance sheet, Sanlam would include all the items of the balance sheet in the translation sheet as above.

Assume that the Indian rupee weakens against the Canadian Dollar on March 31, 2017 such that CAD 0.01 = INR 1. When preparing the balance sheet, Sanlam must decide on the exchange rate to use in translating Sanke’s revenue to Canadian Dollars. The methods that it can use are as follows:

1. Translating Sanke’s amounts at the current exchange rate of CAD 0.01, which is the spot exchange rate on the balance sheet date
2. Translating the monetary items only at the current exchange rate, non-monetary items at the historical exchange rate of CAD 0.01.

Monetary items include cash and receivables (payables). Non-monetary assets include inventory, fixed assets, and intangibles. Non-monetary liabilities include deferred revenue.

Since sales is a monetary item, Sanlam will use the current exchange rate of CAD 0.01 to translate Sanke’s sales on March 31 balance sheet. Assuming that Sanke did not make additional sales from December 31, 2016 to March 31, 2017, the translation worksheet is as follows:

$$\textbf{Translation Worksheet for Sanke, December 31, 2017}$$

$$\small{\begin{array}{l|c|c|c|c} {}& \textbf{INR} & \textbf{Exchange Rate CAD} & \textbf{CAD} & {\textbf{Change in CAD Value}\\ \textbf{since December 31, 2016}}\\ \hline\text{Sales/ revenue} & 500,000 & 0.01\text{C} & 5,000 & 4,000\\ \end{array}}$$

Note: C = Current exchange rate, and H = Historical exchange rate

The total sales are written down from December 31, 2016 to March 31, 2017 by CAD 4,000, resulting in an inventory loss.

In conclusion, if the subsidiary’s currency appreciates against the parent company’s reporting currency over a given period, the amount of sales translated into the parent company will be higher. The converse is also true.

## Question

The Indian rupee strengthened against the Canadian Dollar on 31 March 2017, such that CAD 0.02 = INR 1. The change in Canadian Dollar value that Sanlam realizes from Sanke’s sales since December 31, 2016 is closest to:

A. A gain of CAD 1,000.

B. A loss of CAD 1,000.

C. No gain or loss.

#### Solution

Since sales is a monetary item, it is translated using the current exchange rate, which is CAD 0.01 = INR 1. The translation worksheet is as follows:

$$\textbf{Translation Worksheet for Sanke, December 31, 2017}$$

$$\small{\begin{array}{l|c|c|c|c} {}& \textbf{INR} & \textbf{Exchange Rate CAD} & \textbf{CAD} & {\textbf{Change in CAD Value}\\ \textbf{since 31 Dec 2016}}\\ \hline\text{Sales/ revenue} & 500,000 & 0.02\text{C} & 10,000 & 1,000\\ \end{array}}$$

Where C = Current exchange rate and H= historical exchange rate

Therefore, there will be a sales gain of CAD 1,000.

LOS 13 (c) Analyze how changes in exchange rates affect the translated sales of the subsidiary and the parent company.

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