Question

Compare and contrast the current rate method and the temporal method of accounting for translation exposure.

Answer 1

Answer:

Under the current rate method, all assets are translated at the exchange rate in effect on the date the accounts are translated. Under the temporal method, monetary assets (cash, marketable securities, and accounts receivable) are translated (accountants prefer the technical term remeasured)at the current exchange rate, but inventory and fixed assets are translated at the exchange rate that was in effect at the time the asset was acquired. (Exceptions exist where the local inflation rate exceeds 100% over a three-year period).

The major concept underlying the current rate method is that the entire foreign investment is exposed to foreign exchange risk.Therefore all assets andliabilities are translated at the current exchange rate.Balance sheet exposure under this concept is equal to the net investment.The major concept underlying the temporal method is that the translation process should result in a set of translated U.S. dollar financial statements as if the foreign subsidiary’s transactions had actually been carried out usingU.S. dollars.To achieve this objective, assets carried at historical cost and stockholders’ equity are translated at historical exchange rates.