Question

10-15. What are the major methods for translating foreign-currency denominated financial statements into the financial statements of the parent firm? (2 points)

13-13. Explain the payment methods that exporters typically use. What is the most reliable payment method and how do exporters carry it out? (2 points)

13-19. What steps can managers take to minimize the risks of global sourcing? (3 points)

Answer 1

What are the major methods for translating foreign-currency denominated financial statements into the financial statements of the parent firm?

Current Rate Method

Under the current rate method, all assets and liabilities are translated using the current rate -- the exchange rate on the balance sheet date -- rather than when the translation is performed. Items in the equity section, including the closing entry of dividends to retained earnings, are translated using historical rates, or rates at the time each of transactions occurred. Income statement items are also translated using actual exchange rates, or rates at the dates when revenues and expenses are recognized. However, given the impracticability of applying different rates to numerous income statement items, the Financial Accounting Standards Board permits the use of an average rate for the statement period.

Temporary Rate Method

Unlike the current rate method, which uses one single exchange rate for all asset and liability items, the temporary rate method uses both current rate and historical rate. The principle is that balance sheet items should be translated based on how they are carried on an entity's books. Some are valued and carried at fair market value, such as receivables, and others are valued and carried at historical purchase cost, such as fixed assets. When an item regularly adjusts and updates its carrying value, the value is then temporary in nature, and the temporary rate method recognizes that. It does not attempt to assign a fixed, historical exchange rate to translate a value that is no longer valid. Assets and liabilities that are carried at current values are translated at the current exchange rate, and items carried at historical costs are translated at their respective historical exchange rates.

Monetary Method

Like the temporary rate method, the monetary method also treats asset and liability items differently. The monetary method makes the distinction of monetary vs. non-monetary assets and liabilities. The principle is that monetary accounts are readily convertible to cash and their values fluctuate over time. Therefore, applying a historical rate to lock in the original value does not reflect the economic reality of how monetary items such as marketable securities can change in value over time. As such, the monetary method translates monetary accounts at the current exchange rate and non-monetary accounts such as land at historical rates.