Financial Translation and Reporting Issues

Under the current rate method of translation, the key fundamental concept is that the entire amount of foreign investment is exposed to foreign exchange risk. Thus, the current exchange rate is used to convert all the assets and liabilities. Further, under the current method of translation, the balance sheet exposure is equivalent to net investment (Walton & Aerts, 2006).

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The main concept under the temporal method is that the process of translation should ensure that there is a set of converted financial statements in U.S. dollar currency. Therefore, the financial statements of the subsidiary need to appear as if they were prepared in the U.S. dollar. Under this method, two types of exchange rates are used to convert the financial statements. These are historical and current exchange rates. Thus, items that are recorded in the books of account using historical costs are converted using a historical exchange rate. Examples are assets and stockholder’s equity (Brigham & Ehrhardt, 2009). On the other hand, items that are maintained using the current value are converted using the current exchange rate. Further, the items that are exposed to translation risk are the monetary assets and liabilities of the foreign subsidiary. This can be attributed to the fact that they are considered to be the payables, receivables, and foreign currency cash of the parent company. For instance, consider a scenario where a foreign currency loses value. This will cause a decrease in foreign currency receivable in U.S. dollar value (Perera & Doupnik, 2014). Thus, the company will report a loss on the books of account. Balance sheet exposure under this approach differs from the current rate approach. The exposure under this method is equivalent to the net transaction exposure. This arises from having receivables and payables in a foreign currency (Harrison, Horngren & Thomas, 2014).

Child Co. Inc. and Parent Co. Inc.

Translation under current rate method

Item Amount (Peso) Exchange rate Amount (U.S. Dollar)
Ending inventory 150,000 $0.38 57,000
Cost of goods sold 450,000 $0.42 189,000

As mentioned above, the current rate method makes use of current exchange rate to convert the items in the financial statements. Therefore, the current exchange rate that will be used to convert the ending inventory is the rate reported on 31st December 2010, that is, $0.38. The resulting value after the conversion is $57,000. On the other hand, the cost of goods sold will be converted using the average of beginning and ending exchange rate, that is, $0.42. This can be attributed to the fact that the components of cost of goods sold occur at different time during the year (Wahlen, Jones & Pagach, 2015).

Translation under temporal method

Item Amount (Peso) Exchange rate Amount (U.S. Dollar)
Ending inventory 150,000 $0.4 60,000
Cost of goods sold
Opening inventory 100,000 $0.5 50,000
Add purchases 500,000 $0.42 210,000
Deduct ending inventory (150,000) $0.4 (60,000)
Cost of goods sold 450,000 $200,000

Under this approach, it can be noted that both historical and current exchange rates are used to convert the items. Opening inventory is converted using the exchange rate at the beginning of the year ($0.45). Further, the value of purchases is translated using the average exchange rate ($0.42). This can be attributed to the fact that purchases are made at different dates during the year. Finally, the ending inventory is translated using spot rate ($0.40). That is, the prevailing rate when the items were purchased (Weil, Schipper & Francis, 2013).

References

Brigham, E., & Ehrhardt, M. (2009). Financial management theory and practice. Boston, USA: South-Western Cengage Learning.

Harrison, W., Horngren, C., & Thomas, C. (2014). Financial accounting. New Jersey, USA: Pearson Education.

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Perera, H., & Doupnik, T. (2014). International accounting. New York, USA: McGraw-Hill Education.

Wahlen, J., Jones, J., & Pagach, D. (2015). Intermediate accounting: reporting and analysis. Boston, USA: Cengage Learning.

Walton, P., & Aerts, W. (2006). Global financial accounting and reporting: principles and analysis. Boston, USA: South-Western Cengage Learning.

Weil, R., Schipper, K., & Francis, J. (2013). Financial accounting: an introduction to concepts, methods and uses. Boston, USA: Cengage Learning.

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