The document discusses various methods for translating foreign currency financial statements, including the temporal method, current rate method, and monetary-nonmonetary method. It evaluates the strengths and weaknesses of each method and recommends that the temporal method is best for preserving the underlying accounting measurements. Examples are provided to illustrate the translation of specific accounts under different methods when the foreign currency is the functional currency versus when the parent currency is the functional currency.

1. INTERNATIONAL ACCOUNTING
Frederick D. S. Choi
Gary K. Meek
Chapter 6: Foreign Currency
Translation

2. LEARNING OBJECTIVE:
1. Describe the nature of foreign currency
transactions done in the spot, forward, and swap
markets.
2. Understand the foreign currency translation terms.
3. Explain the difference between a translation gain
or loss and a transaction gain or loss.
4. Comprehend alternative foreign currency
translation methods that exist and their rationale.

3. LEARNING OBJECTIVE:
5. Evaluate which of the available foreign currency
translation methods are best under which specific
business and currency market conditions.
6. Compare and contrast the financial statement effects
of the temporal versus the current rate method of
foreign currency translation.
7. Understand the relationship between foreign currency
translation and inflation.
8. Appreciate how foreign currency translation is handled
outside the United States.

9. FOREIGN CURRENCY TRANSACTIONS

10. FOREIGN CURRENCY TRANSACTIONS

11. SINGLE-TRANSACTION PERSPECTIVE

12. TWO-TRANSACTION PERSPECTIVE
 Under a two-transaction perspective, collection of
the foreign currency receivable is considered a
separate event from the sale that gave rise to it.

13. EXAMPLE 1
 On September 1, 2015, Cormorant Company purchased
merchandise from Osaka Company of Japan for
20,000,000 yen payable on October 1, 2015. The spot
rate for yen was $0.0079 on September 1 and the spot
rate was $0.0077 on October 1.
Required:
1. Did the exchange rate strength or weaken from
September to October and what are the implications
for Cormorant’s business?
2. What journal entry did Cormorant record on
September 1, 2015?
3. What journal entry did Cormorant record on October 1,
2015?

14. EXAMPLE 2
 On October 15, 2015, Ibis Corporation, a French
company, ordered merchandise listed on the Internet for
20,000 Euros from Spoonbill Corporation, a US
corporation, which immediately accepted the order. The
Euro rate was $1.20 US on October 15. On November
15, 2015 Spoonbill shipped the goods and billed Ibis the
purchase price of 20,000 Euros when the Euro rate was
$1.30 US. Ibis paid the bill on December 10, 2015.
Three days later Spoonbill exchanged the 20,000 Euros
for US dollars when the Euro rate was $1.28US.
Required:
Compute the foreign currency gains or losses on the
December 31, 2015 financial statements and show your
calculations.

15. EXAMPLE 3
 On November 1, 2013, the Penguin Corporation, a US
corporation, purchased an extruding machine from
Shearwater Corporation, a UK company. The purchase
price was $10,000 and Penguin agreed to pay in pounds
on February 1, 2014. Both corporations are on a
calendar year accounting period. Assume that the spot
rates for the British pound on November 1, 2013,
December 31, 2013, and February 1, 2014, are $1.60,
$1.62, and $1.66, respectively.
Required:
Record the November 1, December 31, and February 1
transactions in the General Journals of Penguin
Corporation and Shearwater Corporation. If no entry is
required on a particular date, indicate “No entry” in the
General Journal.

16. FOREIGN CURRENCY TRANSLATION
 Companies operating internationally use a variety
of methods to express, in terms of their domestic
currency, the assets, liabilities, revenues, and
expenses that are stated in a foreign currency.

17. SINGLE RATE METHOD
 The single rate method, long popular in Europe,
applies a single exchange rate, the current or
closing rate, to all foreign currency assets and
liabilities. Foreign currency revenues and expenses
are generally translated at exchange rates
prevailing when these items are recognized. For
convenience, however, revenues and expenses are
typically translated by an appropriately weighted
average of current exchange rates for the period.

18. MULTIPLE RATE METHODS
CURRENT–NONCURRENT METHOD
 a foreign subsidiary’s current assets (assets that
are usually converted to cash within a year) and
current liabilities (obligations that mature within a
year) are translated into their parent company’s
reporting currency at the current rate. Noncurrent
assets and liabilities are translated at historical
rates.

19. MULTIPLE RATE METHODS
CURRENT–NONCURRENT METHOD
 Income statement items (except for depreciation
and amortization charges) are translated at average
rates applicable to each month of operation or on
the basis of weighted averages covering the whole
period being reported. Depreciation and
amortization charges are translated at the historical
rates in effect when the related assets were
acquired.

20. MULTIPLE RATE METHODS
CURRENT–NONCURRENT METHOD
 Unfortunately, this method does not often square
with reality. Using the year-end rate to translate
current assets implies that all foreign currency
cash, receivables, and inventories are equally
exposed to exchange risk; that is, will be worth
more or less in parent currency if the exchange rate
changes during the year.

21. MULTIPLE RATE METHODS
MONETARY–NONMONETARY METHOD
 a balance sheet classification scheme to determine
appropriate translation rates. Monetary assets and
liabilities; that is, claims to and obligations to pay a
fixed amount of currency in the future are translated
at the current rate. Nonmonetary items—fixed
assets, long-term investments, and inventories are
translated at historical rates. Income statement
items are translated under procedures similar to
those described for the current–noncurrent
framework.

22. MULTIPLE RATE METHODS
MONETARY–NONMONETARY METHOD
Note, however, that the monetary–nonmonetary
method also relies on a classification scheme to
determine appropriate translation rates. This may
lead to inappropriate results. For example, this
method translates all nonmonetary assets at historical
rates, which is not reasonable for assets stated at
current market values (such as investment securities
and inventory and fixed assets written down to
market).

23. MULTIPLE RATE METHODS
MONETARY–NONMONETARY METHOD
 Multiplying the current market value of a
nonmonetary asset by a historical exchange rate
yields an amount in the domestic currency that is
neither the item’s current equivalent nor its
historical cost. This method also distorts profit
margins by matching sales at current prices and
translation rates against cost of sales measured at
historical costs and translation rates.

24. MULTIPLE RATE METHODS
TEMPORAL METHOD
In the temporal method, monetary items such as
cash, receivables, and payables are translated at the
current rate. Nonmonetary items are translated at
rates that preserve their original measurement bases.
Specifically, assets carried on the foreign currency
statements at historical cost are translated at the
historical rate.

25. MULTIPLE RATE METHODS
TEMPORAL METHOD
When nonmonetary items abroad are valued at
historical cost, the translation procedures resulting
from the temporal method are virtually identical to
those produced by the monetary–nonmonetary
method. The two translation methods differ only if
other asset valuation bases are employed, such as
replacement cost, market values, or discounted cash
flows.

26. MULTIPLE RATE METHODS
The current rate method presumes that the entire foreign
operation is exposed to exchange rate risk since all assets
and liabilities are translated at the year-end exchange rate.
The current–noncurrent rate method presumes that only
the current assets and liabilities are so exposed,
while the monetary–nonmonetary method presumes that
monetary assets and liabilities are exposed.
In contrast, the temporal method is designed to preserve
the underlying theoretical basis of accounting
measurement used in preparing the financial statements
being translated.

27. WHICH IS BEST?
The object of translation is to change the unit of
measure for financial statements of foreign
subsidiaries to the domestic currency, and to make
the foreign statements conform to accounting
principles generally accepted in the country of the
parent company. We think these objectives are best
achieved by translation methods that use historical
rates of exchange.

28. WHICH IS BEST?
The temporal principle is appropriate, as it changes a
measurement in foreign currency into a measurement
in domestic currency without changing the basis of
measurement. The temporal translation method is
easily adapted to processes that make accounting
adjustments during the translation.

29. WHICH IS BEST?
When this is so, adjustments for differences between
two or more sets of accounting concepts and
practices are made along with the translation of
currency amounts. For example, inventories or
certain liabilities may be restated according to
accounting practices different from those originally
used. The temporal principle can accommodate any
asset valuation framework, be it historical cost,
current replacement price, or net realizable values.

30. WHICH IS BEST?
The current rate method is also useful when the
accounts of an independent company are translated
for the convenience of foreign stockholders or other
external user groups.

31. WHICH IS BEST?
It is also appropriate when price-level-adjusted
account are translated to another currency. If reliable
price-level adjustments are made in a given set of
accounts and if domestic price-level changes for the
currency are reflected closely in related foreign
exchange rate movements, the current rate
translation of price-level adjusted data yields results
that are comparable to translating historical cost
accounts under the historical rate translation method.

32. APPROPRIATE CURRENT RATE
Thus far we have referred to rates of exchange used
in translation methods as either historical or current.
Average rates are often used in income statements
for expediency. The choice of an appropriate
exchange rate is not clear-cut because several
exchange rates are in effect for any currency at any
time. There are buying and selling (bid and ask)
rates, spot rates and forward rates, official rates and
free-market rates, and so on.

33. APPROPRIATE CURRENT RATE
 We believe that an appropriate translation rate
should reflect economic and business reality as
closely as possible. The free-market rate quoted for
spot transactions in the country where the accounts
to be translated originate is a rate that appropriately
measures current transaction values.

34. TRANSLATION GAINS AND LOSSES
Exclusion of translation adjustments in current
income is generally advocated because these
adjustments merely result from a restatement
process. Changes in the domestic currency
equivalents of a foreign subsidiary’s net assets are
unrealized and have no effect on the local currency
cash flows generated by the foreign entity. Therefore,
it would be misleading to include such adjustments in
current income. Under these circumstances,
translation adjustments are accumulated separately
as a part of consolidated equity.

35. TRANSLATION WHEN LOCAL CURRENCY IS
THE FUNCTIONAL CURRENCY
If the functional currency is the foreign currency in
which the foreign entity’s records are kept, its
financial statements are translated to dollars using
the current rate method. Resulting translation gains or
losses are disclosed in a separate component of
consolidated equity. This preserves the financial
statement ratios as calculated from the local currency
statements. The following current rate procedures are
used:

36. TRANSLATION WHEN LOCAL CURRENCY IS
THE FUNCTIONAL CURRENCY
1. All foreign currency assets and liabilities are
translated to dollars using the exchange rate
prevailing as of the balance sheet date; capital
accounts are translated at historical rates.
2. Revenues and expenses are translated using the
exchange rate prevailing on the transaction date,
although weighted average rates can be used for
expediency.
3. Translation gains and losses are reported in a
separate component of consolidated stockholders’
equity. These exchange adjustments do not go into
the income statement until the foreign operation is
sold or the investment is judged to have permanently
lost value.

37. TRANSLATION WHEN THE PARENT CURRENCY IS
THE FUNCTIONAL CURRENCY
When the parent currency is a foreign entity’s
functional currency, its foreign currency financial
statements are remeasured to dollars using the
temporal method. All translation gains and losses
resulting from the translation process are included in
determining current period income. Specifically:

38. TRANSLATION WHEN THE PARENT CURRENCY IS
THE FUNCTIONAL CURRENCY
1. Monetary assets and liabilities and nonmonetary
assets valued at current market prices are translated
using the rate prevailing as of the financial statement
date; other nonmonetary items and capital accounts
are translated at historical rates.
2. Revenues and expenses are translated using
average exchange rates for the period except those
items related to nonmonetary items (e.g., cost of
sales and depreciation expense), which are
translated using historical rates.
3. Translation gains and losses are reflected in
current income.

39. TRANSLATION WHEN FOREIGN CURRENCY IS THE
FUNCTIONAL CURRENCY
A foreign entity may keep its records in on foreign
currency when its functional currency is another
foreign currency. In this situation, the financial
statements are first remeasured from the local
currency into the functional currency (temporal
method) and then translated into U.S. dollars using
the current rate method. Assume a German parent
company owns a wholly-owned affiliate in Mexico.
The Mexican affiliate subcontracts most of its
production to Brazilian vendors. Hence, the Mexican
affiliate’s functional currency is deemed to be the
Brazilian real.

41. EXAMPLE 1:
For each of the 12 accounts listed in the table below,
select the correct exchange rate to use when either
remeasuring or translating a foreign subsidiary for its
US parent company.
Codes
C = Current exchange rate
H = Historical exchange rate
A = Average exchange rate

42. … EXAMPLE 1:
US dollar is
the functional
Currency
The foreign
currency is the
functional
Currency
1. Accounts receivable
2. Marketable debt securities
carried at cost
3. Inventories carried at cost
4. Deferred income
5. Goodwill
6. Other paid-in capital
7. Depreciation
8. Refundable deposits
9. Common stock
10. Accumulated depreciation on
Buildings
11. Deferred income tax liabilities
12. Accounts payable

43. The following assets of Oriole Corporation’s Romanian
subsidiary have been converted into US dollars at the following
exchange rates:
Current
Rates
Historical
Rates
Accounts
receivable
$ 850,000 $ 875,000
Trademark 600,000 575,000
Property plant
and equipment
1,200,000 900,000
Totals $ 2,650,000 $ 2,350,000
If the functional currency of the subsidiary is the US dollar, the assets should
be reported in the consolidated financial statements of Oriole Corporation
and Subsidiary in the total amount of
TRANSLATE FINANCIAL STATEMENT:
EXAMPLE 2

44. On January 1, 20X5, Pegler Corporation, a US company, acquired 100%
of Selmic Corporation of Canada, paying an excess of 90,000 Canadian
dollars over the book value of Selmic’s net assets. The excess was
allocated to undervalued equipment with a three-year remaining useful
life. Selmic’s functional currency is the Canadian dollar. Exchange
rates for Canadian dollars for 20X5 are:
January 1, 20X5 $.77
Average rate for 20X5 .75
December 31, 20X5 .73
Required:
1. Determine the depreciation expense stated in US dollars on the
excess allocated to equipment for 20X5.
2. Determine the unamortized excess allocated to equipment on
December 31, 20X5.
3. If Selmic’s functional currency was the US dollar, what would be
the depreciation expense on the excess allocated to the
equipment for 20X5?
TRANSLATE FINANCIAL STATEMENT:
EXAMPLE 3

45. TRANSLATE FINANCIAL STATEMENT:
EXAMPLE 4
Peake Corporation, a US company, formed a British subsidiary on January
1, 20X5 by investing £450,000 in exchange for all of the subsidiary’s
no-par common stock. The British subsidiary, Searle Corporation,
purchased real property on April 1, 20X5 at a cost of £500,000, with
£100,000 allocated to land and £400,000 allocated to a building. The
building is depreciated over a 40-year estimated useful life on a
straight-line basis with no salvage value. The British pound is Searle’s
functional currency and its reporting currency. The British economy does
not have high rates of inflation. Exchange rates for the pound on
various dates were:
January 01, 20X5 = 1£ = $1.50
April 01, 20X5 = 1£ = $1.51
December 31, 20X5 = 1£ = $1.58
20X5 average rate = 1£ = $1.56
Searle's adjusted trial balance is presented below for the year ended
December 31, 20X5.

46. TRANSLATE FINANCIAL STATEMENT:
EXAMPLE 4 (CONT.)
Debits:
Cash £ 220,000
Accounts receivable 52,000
Inventory 59,000
Building 400,000
Land 100,000
Depreciation expense 7,500
Other expenses 110,000
Cost of good sold 220,000
Total debits £ 1,168,500
Credits
Accumulated depreciation £ 7,500
Accounts payable 111,000
Common stock 450,000
Retained earnings 0
Equity adjustment 0
Sales revenue 600,000
Total credits £ 1,168,500
Required: Prepare Searle's:
1. Translation working papers;
2. Translated income statement; and
3. Translated balance sheet.

47. EXAMPLE 4 …
Searle Corporation
Translation Working Papers
Debits
Cash 220,000 x $1.58 = $ 347,600
Accounts receivable 52,000 x $1.58 = 82,160
Inventory 59,000 x $1.58 = 93,220
Building 400,000 x $1.58 = 632,000
Land 100,000 x $1.58 = 158,000
Depreciation expense 7,500 x $1.56 = 11,700
Other expenses 110,000 x $1.56 = 171,600
Cost of goods sold 220,000 x $1.56 = 343,200
Total debits $ 1,839,480
Credits
Accumulated depreciation 7,500 x $1.58 = $ 11,850
Accounts payable 111,000 x $1.58 = 175,380
Common stock 450,000 x $1.50 = 675,000
Sales revenue 600,000 x $1.56 = 936,000
Retained earnings 0
Total credits $ 1,798,230
Credit differential $ 41,250

48. EXAMPLE 4 …
Searle Corporation
Translated Income Statement
For the Year Ended December 31, 20X5
Sales revenue $ 936,000
Expenses:
Cost of goods sold ( 343,200 )
Depreciation expense ( 11,700 )
Other expenses ( 171,600 )
Net income $ 409,500

49. EXAMPLE 4 …
Searle Corporation
Translated Balance Sheet
December 31, 20X5
Cash $ 347,600
Accounts receivable 82,160
Inventory 93,220
Building-net 620,150
Land 158,000
Total assets $ 1,301,130
Accounts payable $ 175,380
Common stock 675,000
Retained earnings 409,500
Accumulated comprehensive income 41,250
Total liabilities & equities $ 1,301,130

50. TRANSLATE FINANCIAL STATEMENT:
EXAMPLE 5
Searle Corporation, a British subsidiary of Peake Corporation (a US
company) was formed by Peake on January 1, 20X5 in exchange for all of
the subsidiary's common stock. Searle has now ended its second year of
operations on December 31, 20X6. Relevant exchange rates are:
January 01, 20X5 = 1£ = $1.50
December 31, 20X6 = 1£ = $1.65
20X6 average rate = 1£ = $1.63
Searle's adjusted trial balance is presented below for the calendar year
20X6. The amount of equity adjustment carried over from 20X5 is a credit
balance of $41,250 (in dollars).

51. TRANSLATE FINANCIAL STATEMENT:
EXAMPLE 5 (CONT.)
In Pounds
Debits:
Cash £ 75,000
Accounts receivable 362,000
Inventory 41,000
Building 400,000
Land 100,000
Depreciation expense 10,000
Other expenses 133,000
Cost of good sold 380,000
Total debits £ 1,501,000
Credits
Accumulated depreciation £ 17,500
Accounts payable 154,750
Common stock 450,000
Retained earnings 262,500
Sales revenue 616,250
Total credits £ 1,501,000

52. EXAMPLE 5…
Searle Corporation
Translation Working Papers
Debits
Cash 75,000 x $1.65 = $ 123,750
Accounts receivable 362,000 x $1.65 = 597,300
Inventory 41,000 x $1.65 = 67,650
Building 400,000 x $1.65 = 660,000
Land 100,000 x $1.65 = 165,000
Depreciation expense 10,000 x $1.63 = 16,300
Other expenses 133,000 x $1.63 = 216,790
Cost of goods sold 380,000 x $1.63 = 619,400
Total debits $ 2,466,190
Credits
Accumulated depreciation 17,500 x $1.65 = $ 28,875
Accounts payable 154,750 x $1.65 = 255,338
Common stock 450,000 x $1.50 = 675,000
Sales revenue 616,250 x $1.63 = 1,004,487
Retained earnings 262,500 409,500
Accumulated comprehensive
income 41,250
Total credits $ 2,414,450
Credit differential $ 51,740

53. EXAMPLE 5…
Searle Corporation
Translated Income Statement
for the year ended December 31, 20X6
Sales revenue $ 1,004,487
Expenses:
Cost of goods sold ( 619,400 )
Depreciation expense ( 16,300 )
Other expenses ( 216,790 )
Net income $ 151,997
Retained earnings, January 1, 20X6 409,500
Retained earnings, December 31, 20X6 $ 561,497

54. EXAMPLE 5…
Searle Corporation
Translated Balance Sheet
December 31, 20X6
Cash $ 123,750
Accounts receivable 597,300
Inventory 67,650
Building-net 631,125
Land 165,000
Total assets $ 1,584,825
Accounts payable $ 255,338
Common stock 675,000
Retained earnings 561,497
Accumulated comprehensive income ($41,250 + $51,740) 92,990
Total liabilities & equities $ 1,584,825