Page 59 - FINAL CFA II SLIDES JUNE 2019 DAY 5.2

EXAMPLE: Determining the appropriate translation method (1): A U.S. READING 16: MULTINATIONAL OPERATIONS
multinational firm has a Japanese subsidiary. The subsidiary’s functional
currency is the Japanese yen (¥). The subsidiary’s books and records are
maintained in yen. The parent’s presentation currency is the U.S. dollar.
Determine which foreign currency translation method is appropriate. MODULE 16.2: TRANSLATION

Answer: Since the functional currency and the parent’s presentation currency differ, the current rate method is used to translate the subsidiary’s
financial statements from yen to U.S. dollars.

EXAMPLE: Determining the appropriate translation method (2): Now imagine the Japanese subsidiary’s functional currency is the U.S. dollar. Determine which
foreign currency translation method is appropriate.

Answer: Since the functional currency and the parent’s presentation currency are the same, the temporal method is used to remeasure the subsidiary’s
financial statements from yen to U.S. dollars.

Applying the Temporal Method

• Monetary assets and liabilities (cash, receivables, payables, and short/long-term debt) are remeasured using the current exchange rate.
• All others (inventory, fixed assets, unearned ( deferred) revenue) are nonmonetary and are remeasured at the historical (actual) rate.
NOTE: There is one exception. Nonmonetary assets and liabilities measured on the balance sheet at “fair value” (e.g., inventory carried at
market value) are remeasured at the current exchange rate, not the historical rate.
• Just like the current rate method, common stock and dividends paid are remeasured at the historical (actual) rate.
• Expenses related to nonmonetary assets such as COGS, depreciation expense, and amortization expense are remeasured based on the historical rates
prevailing at the time of purchase.
• Revenues and all other expenses are translated at the average rate.
• Remeasurement gain or loss is recognized in the income statement. This results in more volatile net income as compared to the current rate method
whereby the translation gain or loss is reported in shareholders’ equity.

Inventory and COGS Under the Temporal Method
There can be numerous historical rates to the purchase nonmonetary assets (e.g., inventory, fixed assets, and intangibles) over time. Inventory can be
particularly complicated since the firm’s cost flow assumption (i.e., FIFO, LIFO, or average cost) must also be considered.
• FIFO ending inventory is remeasured based on more recent exchange rates. On the other hand, FIFO COGS consists of costs that are older; thus, the
exchange rates used to remeasure COGS are older.
• Under LIFO, ending inventory consists of older costs; thus, the inventory is remeasured at older exchange rates. LIFO COGS, however, consists of costs
from the most recently purchased goods; thus, COGS is remeasured based on more recent exchange rates.
• Not surprisingly, under the weighted- average method, ending inventory and COGS are remeasured at the weighted-average exchange rate for the period.