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101 Concepts for the Level II Exam

Level II Concept 26: Translation methods


Many companies have operations in foreign countries. Subsidiaries located in foreign countries usually prepare their financial statements in the local currency. IFRS and US GAAP require parent companies to prepare consolidated financial statements in which the assets, liabilities, revenues, and expenses of both domestic and foreign subsidiaries are added to those of the parent company. To prepare consolidated financial statements, parent companies must translate the foreign currency financial statements into the parent’s presentation currency.

If the foreign subsidiary’s functional currency is different from the parent’s presentation currency, the current rate method must be used.

If the foreign subsidiary’s functional currency is same as the parent’s presentation currency, the temporal method must be used.

Current rate method:

Under this method, the foreign entity’s foreign currency financial statements are translated into the parent’s presentation currency using the following procedures:

  1. All assets and liabilities are translated at the current exchange rate at the balance sheet date
  2. Stockholders’ equity accounts are translated at historical exchange rates
  3. Revenues and expenses are translated at the exchange rate that existed when the transactions took place (For practical reasons, a rate that approximates the exchange rates at the dates of the transactions, such as an average exchange rate, may be used)
  4. Net translation gain/loss is unrealized (will be realized when the entity is sold) and is not shown on the income statement. Translation adjustment is reflected in equity.

Temporal method:

Under this method the foreign entity’s foreign currency financial statements are translated into the parent’s presentation currency using the following procedures:

  1. Assets and Liabilities
  1. Monetary assets and liabilities are translated at the current exchange rate.
  2. Non-monetary assets and liabilities measured at historical cost are translated at historical exchange rates.
  3. Non-monetary assets and liabilities measured at current value are translated at the exchange rate at the date when the current value was determined.
  1. Stockholders’ equity accounts are translated at historical exchange rates.
  2. Revenue and Expenses
  1. Revenues and expenses, other than those expenses related to non-monetary assets, are translated at the exchange rate that existed when the transactions took place.
  2. Expenses related to non-monetary assets, such as cost of goods sold (inventory), depreciation (fixed assets), and amortization (intangible assets), are translated at the exchange rates used to translate the related assets.
  3. The translation gain/loss is shown on the income statement.

Instructor’s note: Items highlighted in bold indicate the differences between the temporal method and the current rate method