Temporal vs Current Method

Accounting Exposure

Eiteman et al., Chapter 10

Winter 2004

Accounting Exposure

Accounting exposure, also called translation exposure, results from the need to restate foreign subsidiaries’ financial statements, usually stated in foreign currency, into the parent’s reporting currency when preparing the consolidated financial statements. Restating financial statements may lead to changes in the parent’s net worth or net income.

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Translation Exposure

When converting financial statement items (transactions) denominated in currencies other than the parent currency, two choices of exchange rate are possible: • The historical rate, the exchange rate prevailing at the time of the transaction • The current rate, the exchange rate prevailing at the balance sheet date or during the income statement period

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Translation Exposure

Conversion of financial statements into the parent’s currency creates the following concerns: • The exposure to exchange rate changes • The treatment of translation gains or losses

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Translation Exposure

SFAS 52 provides two translation methods: • The temporal method, or remeasurement process • The current rate method, or translation process

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Translation Exposure

The method used to restate financial statements is based on the choice of functional currency for each subsidiary. The functional currency is the primary currency used in the subsidiary’s operations. This currency may be the foreign subsidiary’s local currency, the parent’s currency, or a third currency.

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Translation Exposure

There exists three categories of foreign operations:

• Relatively self-contained, independent entities operating primarily in local markets. The functional currency of these entities is generally the local currency. • Significantly integrated operations that serve as sales outlets for the parent’s products and services. The functional currency should be the parent’s currency in this case. • Subsidiaries operating in highly...