{"id":10395,"date":"2023-02-25T05:14:56","date_gmt":"2023-02-25T05:14:56","guid":{"rendered":"https:\/\/analystprep.com\/study-notes\/?p=10395"},"modified":"2026-03-27T14:10:44","modified_gmt":"2026-03-27T14:10:44","slug":"current-rate-temporal-methods-translation-applicable-scenarios-effect-parent-companys-balance-sheet-income-statement","status":"publish","type":"post","link":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/current-rate-temporal-methods-translation-applicable-scenarios-effect-parent-companys-balance-sheet-income-statement\/","title":{"rendered":"Current Rate Method and Temporal Method of Translation"},"content":{"rendered":"<script type=\"application\/ld+json\">\r\n{\r\n  \"@context\": \"https:\/\/schema.org\",\r\n  \"@type\": \"QAPage\",\r\n  \"mainEntity\": {\r\n    \"@type\": \"Question\",\r\n    \"name\": \"When should a parent company use the current rate method instead of the temporal method for translating a foreign subsidiary?\",\r\n    \"text\": \"Under IFRS and U.S. GAAP, when should a parent company use the current rate method instead of the temporal method to translate a foreign subsidiary's financial statements?\",\r\n    \"answerCount\": 1,\r\n    \"acceptedAnswer\": {\r\n      \"@type\": \"Answer\",\r\n      \"text\": \"The parent uses the current rate method when the subsidiary\u2019s functional currency is its local currency, which is different from the parent\u2019s presentation currency. In this case, the subsidiary is viewed as a separate and self-contained entity, so assets and liabilities are translated at the current exchange rate, equity at historical rates, and income statement items at average rates. Translation gains and losses bypass net income and are recorded in other comprehensive income. The temporal method is reserved for situations in which the functional currency is the parent\u2019s presentation currency or a highly inflationary environment requires remeasurement.\"\r\n    }\r\n  }\r\n}\r\n<\/script>\r\n<p><iframe loading=\"lazy\" src=\"\/\/www.youtube.com\/embed\/Xbr1G7tg8Fk\" width=\"611\" height=\"343\" allowfullscreen=\"allowfullscreen\"><\/iframe><\/p>\r\n\r\n<p>Translation refers to converting the functional currency into the parent\u2019s presentation currency. The procedures specified by IFRS and US GAAP for translating foreign currency financial statements essentially require the use of either the <b>current rate method <\/b>or\u00a0the <b>temporal method<\/b>. The suitable method for an individual foreign entity depends on the functional currency of the entity.<\/p>\r\n<p>According to IASB, the management should take into account the following factors when deciding on the functional currency:<\/p>\r\n<ul>\r\n\t<li style=\"font-weight: 400;\">The currency that impacts the sales prices of goods and services.<\/li>\r\n\t<li style=\"font-weight: 400;\">The currency that influences the company\u2019s operational costs.<\/li>\r\n\t<li style=\"font-weight: 400;\">The currency from which funds are generated.<\/li>\r\n\t<li style=\"font-weight: 400;\">The currency of the country whose forces and regulations mainly determine the sale price of goods.<\/li>\r\n\t<li style=\"font-weight: 400;\">The currency in which receivables from operating activities are retained.<\/li>\r\n<\/ul>\r\n<h2>The Current Rate Method<\/h2>\r\n<p>The current rate method applies when a foreign entity has a functional currency that is <strong>different<\/strong> from the parent\u2019s presentation currency. The parent translates the foreign entity\u2019s financial statements, which are recorded in the subsidiary\u2019s functional currency, into the parent company\u2019s presentation currency.<\/p>\r\n<p>Consider a Germany-based food company, ABC Ltd., that owns 10% of a Mexican company, XYZ Ltd. ABC primarily uses the euro as the presentation currency, and it does not control XYZ\u2019s operations. XYZ is self-sustaining and much delinked from ABC. Therefore, XYZ uses its local currency, the Mexican Peso (MXN), as its functional currency. The current rate method is applicable in this case to translate XYZ\u2019s assets and liabilities from Mexican Pesos, the functional currency, to ABC\u2019s presentation currency, the euro.<\/p>\r\n<h3>How It Works<\/h3>\r\n<p>Each <b>income statement<\/b> element, i.e., revenues, and expenses, is translated at the <b>average exchange rate<\/b> during the reporting period. On the other hand, <b>all balance sheet items<\/b> are translated at the <b>current exchange rate<\/b> on the balance sheet date. Shareholder\u2019s equity, mostly made up of common stock and dividends, is translated at the <b>historical exchange rate<\/b>. This will be the rate in effect when the assets are acquired.<\/p>\r\n<p><b>Cumulative translation adjustment<\/b> is a translation gain\/loss caused by foreign currency exchange rate fluctuation. It is recognized under the shareholder\u2019s equity on the balance sheet and is required to keep the translated balance sheet balanced.<b> Balance sheet exposure<\/b> to the foreign currency exchange rate is equal to the <b>net asset (equity)<\/b> position of the subsidiary.<\/p>\r\n<p>$$ \\text{Net assets (Equity) = Total assets \u2013 Total Liabilities = Equity} $$<\/p>\r\n<p>If the local currency <b>appreciates<\/b> against the parent\u2019s presentation currency, the exposure is <b>positive <\/b>and will result in a gain in the cumulative translation adjustment.<\/p>\r\n<h2>The Temporal Method<\/h2>\r\n<p>This translation method is applicable when the subsidiary\u2019s functional currency is the <strong>same<\/strong> as the parent\u2019s presentation currency. The local currency deviates from the functional and the presentation currencies. <b>Re-measurement <\/b>refers to the translation of the local currency to a foreign currency using the temporal method.<\/p>\r\n<p>Under this method, assets and liabilities are classified as either <b>monetary<\/b> or <b>non-monetary<\/b>. Monetary assets and liabilities are items that are settled in cash, which include cash, receivables, payables, and debt. Non-monetary assets and liabilities are not settled in cash. They include inventory, fixed assets, intangible assets, and unearned revenue.<\/p>\r\n<p>For example, Pearson is a hypothetical company based in Canada, and it uses Canadian Dollars (CAD) as its presentation currency. Pearson owns 100% of ACK, a company based in India, and so it controls ACK\u2019s operation decisions. Since ACK is well integrated with the parent, it will use Canadian Dollars as its functional currency. As Pearson\u2019s presentation currency is similar to ACK\u2019s functional currency, it will use the temporal method to translate ACK\u2019s assets and liabilities.<\/p>\r\n<h3>How It Works<\/h3>\r\n<p>Monetary assets and liabilities, such as accounts payable, cash, and accounts receivable, are translated at the <b>current (end-of-period) rates<\/b> under both the temporal and the current rate method is used. However, non-monetary assets and liabilities such as inventory, fixed assets, and intangible assets are translated at the <b>historical exchange rate<\/b>. The historical exchange rate can be taken as the rate on the date on which the assets were acquired or purchased. <b>Common stock and dividends<\/b> are also translated at the <b>historical exchange rate<\/b>.<\/p>\r\n<p>Expenses related to non-monetary assets, such as the <b>cost of goods and services (COGS) <\/b>and depreciation, are translated at the historical exchange rate. Revenue and other expenses are translated using the <b>average exchange rate<\/b>. It is crucial to note that the historical rate differs based on the inventory costing method used.<\/p>\r\n<p><b>Under US GAAP, re-measurement <\/b>refers to the process of translating foreign currency financial statements of a foreign operation that has the parent\u2019s presentation currency as its functional currency. A temporal method is applied here. <b>Re-measurement gain\/loss<\/b> is reported on the <b>income statement<\/b>. If the local currency appreciates relative to the presentation currency, the result will be a <b>re-measurement gain <\/b>and vice versa.<\/p>\r\n<p>The balance sheet exposure associated with the temporal method is equal to the foreign subsidiary\u2019s net monetary asset position.<\/p>\r\n<p>$$ \\text{Net monetary asset position = Net monetary assets \u2013 Net monetary liabilities} $$<\/p>\r\n<h4>Example: Determining the Appropriate Translation Method in Various Scenarios<\/h4>\r\n<p>H Ltd is based in Belgium and complies with International Financial Reporting Standards (IFRS). H used EUR100 million of its cash and borrowed an equal amount to open a subsidiary in Switzerland. The funds were converted into Swiss Franc (CHF) on 31 December 2016 at an exchange rate of EUR1.00 = CHF1.10 and used to purchase CHF 90 million in fixed assets and CHF 10 million of inventories. An analyst wants to explore various scenarios to determine the potential impact on H Ltd.\u2019s consolidated financial statements. No further information is available, and all other economic factors in Belgium are held constant. It is believed that the euro will appreciate against the Swiss Franc for the foreseeable future.<\/p>\r\n<p>If the euro is chosen as the Switzerland subsidiary\u2019s functional currency, H Ltd. will translate its fixed assets using <b>the rate at which the assets were purchased<\/b>. <b>The temporal method<\/b> must be used when the parent\u2019s currency is chosen as the functional currency. Under the temporal method, the fixed assets are translated using the rate in effect at the time the assets were acquired.<\/p>\r\n<p>If the Swiss Franc is chosen as the Switzerland subsidiary\u2019s functional currency, H ltd will translate its inventory using the <b>rate in effect at the end of the reporting period<\/b>. The <b>current rate method<\/b> is used since the foreign currency is chosen to be the functional currency. All assets and liabilities are translated at the current (end-of-period) rate.<\/p>\r\n<p>Assume that the euro is chosen as the Switzerland subsidiary\u2019s functional currency. In that case, H Ltd. will translate its accounts receivable using the <b>rate in effect at the end of the reporting period <\/b>since monetary assets and liabilities such as accounts receivable are translated at current (end-of-period) rates regardless of whether the temporal or current rate method is used.<\/p>\r\n<blockquote>\r\n<h2>Question<\/h2>\r\n<p>Assume that the euro appreciates against the Swiss Franc. If the Swiss Franc is chosen to be the Switzerland subsidiary\u2019s functional currency, H Ltd. will <i>most likely<\/i> report a (an):<\/p>\r\n<p>\u00a0 \u00a0 \u00a0A. Subtraction from the cumulative translation adjustment.<\/p>\r\n<p>\u00a0 \u00a0 \u00a0B. Addition to the cumulative translation adjustment.<\/p>\r\n<p>\u00a0 \u00a0 \u00a0C. Translation gain\/loss as a component of the net income.<\/p>\r\n<h4>Solution<\/h4>\r\n<p><strong>The correct answer is A<\/strong>.<\/p>\r\n<p><b>The current rate method <\/b>must be used when the foreign currency is chosen as the functional currency. All gains or losses from translation are reported as a <b>cumulative translation adjustment<\/b> to shareholder equity. When the foreign currency decreases in value (weakens), the current rate method results in a negative translation adjustment in stockholders\u2019 equity.<\/p>\r\n<p><b>B is incorrect<\/b>. An addition to the cumulative translation adjustment is most likely to result from the foreign currency appreciating (increasing in value).<\/p>\r\n<p><b>C is incorrect<\/b>. A translation gain or loss arises under the temporal method when the foreign currency appreciates\/depreciates relative to the parent company\u2019s presentation currency.<\/p>\r\n<\/blockquote>\r\n<p>Reading 13: Multinational Operations<\/p>\r\n<p><em>LOS 13 (d) Compare the current rate method and the temporal method, evaluate the effects of each on the parent company\u2019s balance sheet and income, and determine which method is appropriate in various scenarios.<\/em><\/p>","protected":false},"excerpt":{"rendered":"<p>Translation refers to converting the functional currency into the parent\u2019s presentation currency. The procedures specified by IFRS and US GAAP for translating foreign currency financial statements essentially require the use of either the current rate method or\u00a0the temporal method. The&#8230;<\/p>\n","protected":false},"author":5,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[102,312],"tags":[216,127,313,128],"class_list":["post-10395","post","type-post","status-publish","format-standard","hentry","category-cfa-level-2","category-financial-reporting-and-analysis-fra","tag-cfa-level-2","tag-current-rate","tag-financial-reporting-and-analysis-fra","tag-temporal-methods-of-translation","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v26.9 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Current Rate vs Temporal Method Translation<\/title>\n<meta name=\"description\" content=\"Learn how current rate and temporal methods differ, how functional currency is determined, and how exchange rate changes affect financial statements.\" \/>\n<meta name=\"robots\" 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