Financial Reporting - Chp 18 Flashcards
Two methods to translate financial statements of subsidiary to parent
o Remeasurement – converting local currency into functional currency using temporal method
o Translation – convering functional currency into parents presentation currency using current rate method. AKA “all current” method.
when to use current rate method
o If functional currency is different from parents presentation currency, current rate method used. Usually when subsidiary id pretty independent.
when to use temporal method
o If functional currency is same as parents presentation currency, temporal method used to remeasure foreign currency in financial statements. Usually occurs when subsidiary is well integrated with parent.
when to use current rate and temporal method
o If presentation, local, and functional currency all different, both temporal and current rate methods used. (ex. Us company owns german firm whose functional currency is swiss
Applying current rate method
o All income statement accounts are translated at average rate (Net income, sales)
o All balance sheet accounts translate at current rate except for common stock, which is translated at a historical rate that applied when stock was issued (and except equity)
o Dividends translated at rate that applied when they were declared
Translation gain or loss is reported in CTA section of shareholder equity as a part of cumulative
Applying temporal method
o Monetary assets and liabilities remeasured using current exchange rate (includes long term debt)
o All other assets and liabilities are considered nonmonetary and remeasured at historical rate. Usually inventory, fixed assets, intangibles
o Like current rate, common stock and dividends paid remeasured at historical rate
o Expenses related to nonmonetary assets such as COGS, depreciation expense, remeasured based on historical rate at time of purchase
o Revenues and all other expense translated at average rate
o Remeasurement gain or loss recognized in income statement. This makes temporal method more volatile net income as compared to current rate method.
Exposure to exchange rates
Why do temporal method and current rate method differ?
§ Because COGS and depreciation are translated at different rates
§ Translation gain/loss is different b/t the two methods, may not even be same sign
§ Net income different b/t the two methods
§ Total assets are different b/t the two methods b/c inventory and net fixed assets are different
How are financial ratios affected by translation
Pure balance sheet and pure income statement ratios will be the same.
If the foreign currency is depreciating, translated mixed ratios (with an income statement item in the numerator and an end-of-period balance sheet item in the denominator) will be larger than the original ratio.
If the foreign currency is appreciating, translated mixed ratios (with an income statement item in the numerator and an end-of-period balance sheet item in the denominator) will be smaller than the original ratio.
examples of pure ratios: quick ratio,
examples of mixed ratios: total asset turnover,
Examples of pure financialstatement ratios
All components come from jsut balance sheet or income statement
ex: profit measures ( gross profit/revenue, operating profit/revenue, net profit/revenue)
where is translation gain/loss reported for the two methods
- · Current Rate: translation loss reported in shareholder equity as part of CTA
· Temporal: translation gain reported in income statement. This is more volatile net income.
