Currency Comparison Methods in Modern Accounting

In the realm of international finance, the comparison of currencies is a crucial aspect of accounting and financial reporting. Two primary methods are employed for this purpose: the current rate method and the temporal method. Each method has distinct characteristics and is applicable in different scenarios.

Current Rate Method

The current rate method is a widely used technique for currency translation. It is employed when a foreign entity operates with a functional currency that differs from the parent company’s presentation currency. Under this method, the foreign entity’s financial statements, originally recorded in its functional currency, are translated into the parent company’s presentation currency.

Key Features of the Current Rate Method

• Income statement elements, including revenues and expenses, are translated using the average exchange rate prevailing during the reporting period.
• Balance sheet items, such as assets and liabilities, are translated at the current exchange rate on the balance sheet date.
• Shareholder’s equity, primarily comprising common stock and dividends, is translated at the historical exchange rate, which is the rate in effect when the assets were acquired.
• Cumulative translation adjustment, a translation gain or loss resulting from currency exchange rate fluctuations, is recognized under the shareholder’s equity on the balance sheet, ensuring the balance sheet remains balanced.

Temporal Method

The temporal method is another method used for currency translation. It is applicable when the subsidiary’s functional currency is identical to the parent company’s presentation currency. In such cases, re-measurement is performed, which involves translating the local currency into a foreign currency using the temporal method.

Key Features of the Temporal Method

• Monetary assets and liabilities, such as cash, accounts receivable, and accounts payable, are translated at the current (end-of-period) rates under both the temporal and current rate methods.
• Non-monetary assets and liabilities, such as inventory, fixed assets, and intangible assets, are translated at the historical exchange rate, which is the rate in effect when the assets were acquired or purchased.
• Common stock and dividends are also translated at the historical exchange rate.
• Expenses related to non-monetary assets, such as cost of goods sold and depreciation, are translated at the historical exchange rate.
• Revenue and other expenses are translated using the average exchange rate.
• Re-measurement gain or loss is reported on the income statement, impacting the net income.

Conclusion

The choice between the current rate method and the temporal method depends on the specific circumstances of the foreign entity and its relationship with the parent company. The functional currency of the entity, the level of integration with the parent company, and the applicable accounting standards all play a role in determining the appropriate method.

References:

1. Current Rate Method: Overview and Calculations
2. Current Rate and Temporal Methods of Translation – CFA, FRM, and Actuarial Exams Study Notes
3. Exchange Rates: What They Are, How They Work, Why They Fluctuate

FAQs

What is the most commonly used method of currency comparison today?

The current rate method is the most widely used method of currency comparison, particularly when the foreign entity’s functional currency differs from the parent company’s presentation currency.

What are the key elements translated at the average exchange rate under the current rate method?

Under the current rate method, income statement elements such as revenues and expenses are translated at the average exchange rate prevailing during the reporting period.

How are balance sheet items translated under the temporal method?

In the temporal method, monetary assets and liabilities are translated at the current (end-of-period) rates, while non-monetary assets and liabilities are translated at the historical exchange rate.

What is the cumulative translation adjustment, and where is it reported?

The cumulative translation adjustment is a translation gain or loss resulting from currency exchange rate fluctuations. It is recognized under the shareholder’s equity on the balance sheet, ensuring the balance sheet remains balanced.

When is the temporal method used for currency comparison?

The temporal method is used when the subsidiary’s functional currency is the same as the parent company’s presentation currency.

What is re-measurement in the context of currency comparison?

Re-measurement refers to the process of translating the local currency into a foreign currency using the temporal method. It involves classifying assets and liabilities as monetary or non-monetary and translating them accordingly.

How are expenses related to non-monetary assets translated under the temporal method?

Expenses related to non-monetary assets, such as cost of goods sold and depreciation, are translated at the historical exchange rate under the temporal method.

Where is the re-measurement gain or loss reported under the temporal method?

The re-measurement gain or loss is reported on the income statement under the temporal method, impacting the net income.