This document discusses various methods for translating foreign currency financial statements when consolidating a foreign subsidiary's statements into a parent company's reporting currency. It provides examples of how the current/noncurrent method, monetary/nonmonetary method, temporal method, and current rate method would account for a change in exchange rates from DM3=$1 to DM2=$1. In general, the methods differ in whether they use the historical or current exchange rate to translate non-monetary assets such as inventory and fixed assets, and whether translation gains/losses affect net income.

2. Foreign Currency Translation
 FCT commonly known as Accounting
Exposure, arises because financial
statements of foreign affiliates which are
stated in a foreign currency, must be restated
in the parent company's reporting currency to
prepare consolidated financial statements

3. Foreign Currency Translation
 To consolidate statements, the following
must be consolidated:
 Language
 Accounting Concepts
 Currency
 What should be included in consolidated
statements?
 Narrow View: Consolidated statements should
include the parent firm and all domestic
subsidiaries
 Wide View: All subsidiaries, regardless of
location, should be consolidated.

4. Why currency Translation
needed?
• Manny company having subsidiary company
in other country
• Different country having different accounting
rules

5. Translation Methods: Example
• Suppose you had 100 British pounds on deposit
in a London bank at the end of 1993 when the
exchange rate is $1.80. To report the deposit on
your 1994 Balance Sheet stated in dollars, you
would translate the deposit at the current rate
and you would report an asset of $180.
• At the end of 1994, you still have the 100
pounds in the bank, but now the exchange rate
is $1.70. To report the deposit on your 1994
Balance Sheet, it would now translate into $170
and you would have an imbalance of $10 to deal
with.

6. Translation Methods: Example
 If you translated at the historical rate, you
would still translate into $180 and there
would be no imbalance

7. Exchange Rates
 Current rate--exchange rate prevailing
as of the financial statement date
 Historical rate--exchange rate prevailing
when a foreign currency asset was first
acquired or a foreign currency liability
was first incurred
 Average rate--simple or weighted
average of either current or historical
exchange rates

8. Two Major Issues
 Which exchange rate should be used to
translate foreign currency balances to
domestic currency?
 How should translation gains and losses
be accounted for? Should they be
included in income?
 Translation methods may employ a
single rate or multiple rates.

9. Translation Methods
 Current/Noncurrent Method
 Monetary/Nonmonetary Method
 Temporal Method
 Current Rate Method

10. Translation Models
• Current-Noncurrent Model
– Current items on the balance sheet
are translated at the current rate.
– Long-term items on the balance sheet
are translated at the historical rate.
– This method of foreign currency
translation was generally accepted in
the United States from the 1930
to1975

11.  COGS is translated at the current rate (it is
based on inventory, a current asset)
 Depreciation is translated at the appropriate
historical rate based on the date of
acquisition of the assets
 Under this method, a foreign subsidiary with
current assets in excess of current liability
will cause a translation gain (loss) if the local
currency appreciates (depreciates)

12. Current/Noncurrent Method
 Current
assets
translated at Balance Sheet Local Current/
Currency Noncurrent
the spot rate.
Cash 2,100 DM $1,050
e.g. DM2=$1 Inventory 1,500 DM $750
 Noncurrent Net fixed assets 3,000 DM $1,000
assets Total Assets 6,600 DM $2,800
translated at Current liabilities 1,200 DM $600
the historical Long-Term debt 1,800 DM $600
rate in effect Common stock 2,700 DM $900
when the Retained earnings 900 DM $700
item was first CTA -------- --------
recorded on Total Liabilities and 6,600 DM $2,800
the books. Equity
e.g. DM3=$1

13. Monetary/Nonmonetary Method
• All monetary balance sheet accounts (cash,
marketable securities, accounts receivable,
notes payable, accounts payable etc.) of a
foreign subsidiary are translated at the
current exchange rate.
• All other nonmonetary balance sheet
accounts (owners’ equity, fixed assets, long
term investments, and inventories) are
translated at the historical exchange rate in
effect when the account was first recorded.

14. Monetary/Nonmonetary Method
 All monetary
balance sheet
accounts are Balance Sheet Local Monetary/
translated at Currency Nonmonetary
the current Cash 2,100 DM $1,050
exchange rate. Inventory 1,500 DM $500
e.g. DM2=$1 Net fixed assets 3,000 DM $1,000
 All other Total Assets 6,600 DM $2,550
balance sheet Current liabilities 1,200 DM $600
accounts are Long-Term debt 1,800 DM $900
translated at Common stock 2,700 DM $900
the historical Retained earnings 900 DM $150
exchange rate CTA -------- --------
in effect when Total Liabilities and 6,600 DM $2,550
the account Equity
was first
recorded.
e.g.DM3=$1

15. difference between Current-Noncurrent and
Monetary-Nonmonetary
 This method differs substantially
with respect to accounts such as
inventory, long-term receivables
and long-term debt

16. Temporal Method
• The underlying principal is that assets and
liabilities should be translated based on
how they are carried on the firm’s books.
• Balance sheet account are translated at
the current exchange rate if they are
carried on the books at their current value.
• Items that are carried on the books at
historical costs are translated at the
historical exchange rates in effect at the
time the firm placed the item on the books.

17. Temporal Method
• Items carried on
the books at Balance Sheet Local Temporal
their current Currency
value are Cash 2,100 DM $1,050
translated at the Inventory 1,500 DM $900
spot exchange Net fixed assets 3,000 DM $1,000
rate. Total Assets 6,600 DM $2,950
e.g. DM2=$1 Current liabilities 1,200 DM $600
Long-Term debt 1,800 DM $900
• Items that are Common stock 2,700 DM $900
carried on the Retained earnings 900 DM $550
books at CTA -------- --------
historical costs Total Liabilities and 6,600 DM $2,950
are translated at Equity
the historical
exchange rates.
e.g. DM3=$1

18. Current Rate Method
 All balance sheet items (except for
stockholder’s equity) are translated at the
current exchange rate.
 Very simple method in application.
 A “plug” equity account named cumulative
translation adjustment is used to make the
balance sheet balance
 Translation gains or losses do not go through
the income statement according to this
method

19. Current Rate Method
• All balance
sheet items Balance Sheet Local Current
(except for Currency Rate
stockholder’s Cash DM2,100 $1,050
equity) are Inventory DM1,500 $750
translated at the Net fixed assets DM3,000 $1,500
current Total Assets DM6,600 $3,300
exchange rate. Current liabilities DM1,200 $600
• A “plug” equity Long-Term debt DM1,800 $900
account named Common stock DM2,700 $900
cumulative Retained earnings DM900 $360
translation CTA -------- $540
adjustment is Total Liabilities DM6,600 $3,300
used to make and Equity
the balance
sheet balance

20. How Various Translation Methods Deal with
a Change from DM3 to DM2 = $1
Balance Sheet Local Current/ Monetary/ Temporal Current
Currency Noncurrent Nonmonetary Rate
Cash 2,100 DM $1,050 $1,050 $1,050 $1,050
Inventory 1,500 DM $750 $500 $900 $750
Net fixed assets 3,000 DM $1,000 $1,000 $1,000 $1,500
Total Assets 6,600 DM $2,800 $2,550 $2,950 $3,300
Current 1,200 DM $600 $600 $600 $600
liabilities
Long-Term 1,800 DM $600 $900 $900 $900
debt
Common stock 2,700 DM $900 $900 $900 $900
Retained 900 DM $700 $150 $550 $360
earnings
earnings
CTA -------- -------- -------- -------- $540
Total 6,600 DM $2,800 $2,550 $2,950 $3,300
Liabilities and
Equity Spot exchange rate

21. How Various Translation Methods Deal with
a Change from DM3 to DM2 = $1
Balance Sheet Local Current/ Monetary/ Temporal Current
Currency Noncurrent Nonmonetary Rate
Cash 2,100 DM $1,050 $1,050 $1,050 $1,050
Inventory 1,500 DM $750 $500 $900 $750
Net fixed assets 3,000 DM $1,000 $1,000 $1,000 $1,500
Total Assets 6,600 DM $2,800 $2,550 $2,950 $3,300
Book
Current 1,200 DM $600 $600 $600 $600
value of
liabilities
inventory
Long-Term 1,800 DM $600 historic $900 $900 $900
debt rate
Common stock 2,700 DM $900 $900 $900 $900
Retained earnings 900 DM $700 $150 $550 $360
earnings
CTA -------- -------- -------- -------- $540
Total 6,600 DM $2,800 $2,550 $2,950 $3,300
Liabilities and Book value of inventory Current value of inventory
Equity at spot exchange rate at spot exchange rate.

22. How Various Translation Methods Deal with
a Change from DM3 to DM2 = $1
Balance Sheet Local Current/ Monetary/ Temporal Current
Currency Noncurrent Nonmonetary Rate
Cash 2,100 DM $1,050 $1,050 $1,050 $1,050
Inventory 1,500 DM $750 $500 $900 $750
Net fixed assets 3,000 DM $1,000 $1,000 $1,000 $1,500
Total Assets 6,600 DM $2,800 $2,550 $2,950 $3,300
Current 1,200 DM $600 $600 $600 $600
liabilities
Long-Term 1,800 DM $600 $900 $900 $900
debt
Common stock 2,700 DM $900 $900 $900 $900
Retained earnings 900 DM $700 $150 $550 $360
earnings
CTA -------- -------- -------- -------- $540
Total 6,600 DM $2,800 $2,550 $2,950 $3,300
Liabilities and historic spot exchange rate.
Equity rate

23. How Various Translation Methods Deal with
a Change from DM3 to DM2 = $1
Balance Sheet Local Current/ Monetary/ Temporal Current
Currency Noncurrent Nonmonetary Rate
Cash 2,100 DM $1,050 $1,050 $1,050 $1,050
Inventory 1,500 DM $750 $500 $900 $750
Net fixed assets 3,000 DM $1,000 $1,000 $1,000 $1,500
Total Assets 6,600 DM $2,800 $2,550 $2,950 $3,300
Current 1,200 DM $600 $600 $600 $600
liabilities
Long-Term 1,800 DM $600 $900 $900 $900
debt
Common stock 2,700 DM $900 $900 $900 $900
Retained earnings 900 DM $700 $150 $550 $360
earnings
CTA -------- -------- -------- -------- $540
Total 6,600 DM $2,800 $2,550 $2,950 $3,300
Liabilities and spot rate
Equity

24. How Various Translation Methods Deal with
a Change from DM3 to DM2 = $1
Balance Sheet Local Current/ Monetary/ Temporal Current
Currency Noncurrent Nonmonetary Rate
Cash 2,100 DM $1,050 $1,050 $1,050 $1,050
Inventory 1,500 DM $750 $500 $900 $750
Net fixed assets 3,000 DM $1,000 $1,000 $1,000 $1,500
Total Assets 6,600 DM $2,800 $2,550 $2,950 $3,300
Current 1,200 DM $600 $600 $600 $600
liabilities
Long-Term 1,800 DM $600 $900 $900 $900
debt
Common stock 2,700 DM $900 $900 $900 $900
Retained earnings 900 DM $700 $150 $550 $360
earnings
CTA -------- -------- -------- -------- $540
Total 6,600 DM $2,800 $2,550 $2,950 $3,300
Liabilities and
historical rate spot rate
Equity

25. How Various Translation Methods Deal with
a Change from DM3 to DM2 = $1
Balance Sheet Local Current/ Monetary/ Temporal Current
Currency Noncurrent Nonmonetary Rate
Cash 2,100 DM $1,050 $1,050 $1,050 $1,050
Inventory 1,500 DM $750 $500 $900 $750
Net fixed assets 3,000 DM $1,000 $1,000 $1,000 $1,500
Total Assets 6,600 DM $2,800 $2,550 $2,950 $3,300
Current 1,200 DM $600 $600 $600 $600
liabilities
Long-Term 1,800 DM $600 $900 $900 $900
debt
Common stock 2,700 DM $900 $900 $900 $900
Retained earnings 900 DM $700 $150 $550 $360
earnings
CTA -------- -------- -------- -------- $540
Total 6,600 DM $2,800 $2,550 $2,950 $3,300
Liabilities and
historical rate
Equity

26. How Various Translation Methods Deal
with a Change from DM3 to DM2 = $1
Balance Sheet Local Current/ Monetary/ Temporal Current
Currency Noncurrent Nonmonetary Rate
Cash 2,100 DM $1,050 $1,050 $1,050 $1,050
Inventory 1,500 DM $750 $500 $900 $750
Net fixed assets 3,000 DM $1,000 $1,000 $1,000 $1,500
Total Assets 6,600 DM $2,800 $2,550 $2,950 $3,300
Current 1,200 DM $600 $600 $600 $600
liabilities
Long-Term 1,800 DM $600 $900 $900 $900
debt
Common stock 2,700 DM $900 $900 $900 $900
Retained earnings 900 DM $700 $150 $550 $360
earnings
CTA -------- -------- -------- -------- $540
Total 6,600 DM $2,800 $2,550 $2,950 $3,300
Liabilities and
From income statement
Equity

27. How Various Translation Methods Deal with a
Change from DM3 to DM2 = $1
Balance Sheet Local Current/ Monetary/ Temporal Current
Currency Noncurrent Nonmonetary Rate
Cash 2,100 DM $1,050 $1,050 $1,050 $1,050
Inventory 1,500 DM $750 $500 $900 $750
Net fixed assets 3,000 DM $1,000 $1,000 $1,000 $1,500
Total Assets 6,600 DM $2,800 $2,550 $2,950 $3,300
Current 1,200 DM $600 $600 $600 $600
liabilities
Long-Term 1,800 DM $600 $900 $900 $900
debt
Common stock 2,700 DM $900 $900 $900 $900
Retained earnings 900 DM $700 $150 $550 $360
earnings
CTA -------- -------- -------- -------- $540
Total 6,600 DM $2,800 $2,550 $2,950 $3,300
Liabilities and Under the current rate method, a “plug” equity account named
Equity cumulative translation adjustment makes the balance sheet balance.

28. How Various Translation Methods Deal with
a Change from DM3 to DM2 = $1
Local Current/ Monetary/ Temporal Current
Income Statement Currency Noncurrent Nonmonetary Rate
Sales 10,000 DM $4,000 $4,000 $4,000 $4,000
COGS 7,500 DM $3,000 $2,500 $3,000 $3,000
Depreciation 1,000 DM $333 $333 $333 $400
Net operating income 1,500 DM $667 $1,167 $667 $600
Income tax (40%) 600 DM $267 $467 $267 $240
Profit after tax 900 DM $400 $700 $400 $360
Foreign exchange gain (loss) $300 -$550 $150
Net income 900 DM $700 $150 $550 $360
Dividends 0 DM $0 $0 $0 $0
Addition to Retained
Earnings 900 DM $700 $150 $550 $360
Sales translate at average exchange rate over the period, DM2.50 = $1

29. How Various Translation Methods Deal with
a Change from DM3 to DM2 = $1
Local Current/ Monetary/ Temporal Current
Income Statement Currency Noncurrent Nonmonetary Rate
Sales 10,000 DM $4,000 $4,000 $4,000 $4,000
COGS 7,500 DM $3,000 $2,500 $3,000 $3,000
Depreciation 1,000 DM $333 $333 $333 $400
Net operating income 1,500 DM $667 $1,167 $667 $600
Income tax (40%) 600 DM $267 $467 $267 $240
Profit after tax 900 DM $400 $700 $400 $360
Foreign exchange gain (loss) $300 -$550 $150
Net income 900 DM $700 $150 $550 $360
Dividends 0 DM $0 $0 $0 $0
Addition to Retained
Earnings 900 DM $700 $150 $550 $360
Translate at DM2.50 = $1 Translate at new exchange rate, DM3.00 = $1

30. How Various Translation Methods Deal with
a Change from DM3 to DM2 = $1
Local Current/ Monetary/ Temporal Current
Income Statement Currency Noncurrent Nonmonetary Rate
Sales 10,000 DM $4,000 $4,000 $4,000 $4,000
COGS 7,500 DM $3,000 $2,500 $3,000 $3,000
Depreciation 1,000 DM $333 $333 $333 $400
Net operating income 1,500 DM $667 $1,167 $667 $600
Income tax (40%) 600 DM $267 $467 $267 $240
Profit after tax 900 DM $400 $700 $400 $360
Foreign exchange gain (loss) $300 -$550 $150
Net income 900 DM $700 $150 $550 $360
Dividends 0 DM $0 $0 $0 $0
Addition to Retained
Earnings 900 DM $700 $150 $550 $360
Translate at DM3 = $1 Translate at average exchange rate, DM2.5 = $1

31. How Various Translation Methods Deal with
a Change from DM3 to DM2 = $1
Local Current/ Monetary/ Temporal Current
Income Statement Currency Noncurrent Nonmonetary Rate
Sales 10,000 DM $4,000 $4,000 $4,000 $4,000
COGS 7,500 DM $3,000 $2,500 $3,000 $3,000
Depreciation 1,000 DM $333 $333 $333 $400
Net operating income 1,500 DM $667 $1,167 $667 $600
Income tax (40%) 600 DM $267 $467 $267 $240
Profit after tax 900 DM $400 $700 $400 $360
Foreign exchange gain (loss) $300 -$550 $150
Net income 900 DM $700 $150 $550 $360
Dividends 0 DM $0 $0 $0 $0
Addition to Retained
Earnings 900 DM $700 $150 $550 $360
Note the effect on after-tax profit.

32. How Various Translation Methods Deal with
a Change from DM3 to DM2 = $1
Local Current/ Monetary/ Temporal Current
Income Statement Currency Noncurrent Nonmonetary Rate
Sales 10,000 DM $4,000 $4,000 $4,000 $4,000
COGS 7,500 DM $3,000 $2,500 $3,000 $3,000
Depreciation 1,000 DM $333 $333 $333 $400
Net operating income 1,500 DM $667 $1,167 $667 $600
Income tax (40%) 600 DM $267 $467 $267 $240
Profit after tax 900 DM $400 $700 $400 $360
Foreign exchange gain (loss) $300 -$550 $150
Net income 900 DM $700 $150 $550 $360
Dividends 0 DM $0 $0 $0 $0
Addition to Retained
Earnings 900 DM $700 $150 $550 $360
Note the effect that foreign exchange gains (losses) has on net income.