Page 53 - FINAL CFA II SLIDES JUNE 2019 DAY 5.2

LOS 16.c: Analyze how changes in exchange rates affect the translated sales
of the subsidiary and parent company. READING 16: MULTINATIONAL OPERATIONS
LOS 16.d: Compare the current rate method and the temporal method,
evaluate how each affects the parent company’s balance sheet and income
statement, and determine which method is appropriate in various scenarios. MODULE 16.2: TRANSLATION

2 methods to remeasure or translate the financial statements of a foreign subsidiary to the parent’s presentation (reporting) currency.
• Remeasurement involves converting the local currency into functional currency using the temporal method.
• Translation involves converting the functional currency into the parent’s presentation (reporting) currency using the current rate method. The current
rate method is also known as the all-current method.

The translation method, current rate or temporal, is determined by the functional currency relative to the parent’s presentation currency. Since the
functional currency is chosen by management, it may not be completely objective. Per IASB, management should consider:
• The currency that influences sales prices for goods and services.
• Currency of the country whose competitive forces and regulations mainly determine the sale price of goods and services.
• The currency that influences labor, material, and other costs.
• The currency from which funds are generated.
• The currency in which receipts from operating activities are usually retained.

The FASB provides similar guidance.
Generally, we can use the following to determine the appropriate translation method:
• If the functional currency and the parent’s presentation currency differ, the current rate
method is used to translate the foreign currency financial statements. Translation usually
involves self-contained, independent subsidiaries whose operating, investing, and
financing activities are decentralized from the parent. See Column 1.
• If the functional currency is the same as the parent’s presentation currency, the temporal
method is used to remeasure the foreign currency financial statements. Remeasurement
usually occurs when a subsidiary is well integrated with the parent (i.e., the parent makes
the operating, investing, and financing decisions). See Column 2.
• In the case where the local currency, the functional currency, and the presentation
currency all differ, both the temporal method and the current rate method are used. For
example, consider a U.S. firm that owns a German subsidiary whose functional currency is
the Swiss franc. In this case, the temporal method is used to remeasure from the local
currency (euros) into the functional currency (Swiss francs). Then, the current rate method
is used to translate from the functional currency (Swiss francs) to the presentation
currency (U.S. dollar). See Column 3.
• If a subsidiary is operating in a hyperinflationary environment, the functional currency is
considered to be the parent’s presentation currency, and the temporal method is used
under U.S. GAAP. Under IFRS, the subsidiary’s financial statements are restated for
inflation and then translated using the current exchange rate. Hyperinflation will be
discussed in more detail later in this topic review.