Translation

There are two methods used to remeasure or translate the financial statements of a foreign subsidiary to the parent’s presentation (reporting) currency.

Remeasurement involves converting the local currency into functional currency using the temporal method. Translation involves converting the functional currency into the parent’s presentation (reporting) currency using the current rate method. The current rate method is also known as the all current method.

Thus, both the remeasurement methodology and the translation methodology result in “translation,” or the conversion of account and transaction balances to another currency. The ensuing discussion should make this distinction clear.

The translation method, current rate or temporal, is determined by the functional currency relative to the parent’s presentation currency. Since the functional currency is chosen by management, it may not be completely objective.

According to the IASB, management should consider the following factors in deciding on the functional currency:

The currency that influences sales prices for goods and services. Currency of the country whose competitive forces and regulations mainly determine the sale price of goods and services. The currency that influences labor, material, and other costs.

The currency from which funds are generated.

The currency in which receipts from operating activities are usually retained.

The FASB provides similar guidance.

Generally, we can use the following to determine the appropriate translation method:

If the functional currency and the parent’s presentation currency differ, the current rate method is used to translate the foreign currency financial statements. Translation usually involves self contained, independent subsidiaries whose operating, investing, and financing activities are decentralized from the parent. See Column 1 of Figure 9.1.

If the functional currency is the same as the parent’s presentation currency, the temporal method (also called the monetary/non monetary method) is used to remeasure the foreign currency financial statements. Remeasurement usually occurs when a subsidiary is well integrated with the parent (i.e., the parent makes the operating, investing, and financing decisions). See Column 2 of Figure 9.1.

In the case where the local currency, the functional currency, and the presentation currency all differ, both the temporal method and the current rate method are used. For example, consider a U.S. firm that owns a German subsidiary whose functional currency is the Swiss franc. In this case, the temporal method is used to remeasure from the local currency (euros) into the functional currency (Swiss francs).

Then, the current rate method is used to translate from the functional currency (Swiss francs) to the presentation currency (U.S. dollar). See Column 3 of Figure 9.1. If a subsidiary is operating in a hyperinflationary environment, the functional currency is considered to be the parent’s presentation currency, and the temporal method is used under U.S. GAAP.

Under IFRS, the subsidiary’s financial statements are restated for inflation and then translated using the current exchange rate. Hyperinflation will be discussed in more detail later in this topic review.

Figure 9.1 illustrates the three ways the local currency may be remeasured and/or translated into the presentation currency of the parent. Note that the choice of the functional currency determines the method used for conversion.

Figure 9.1: Three Methods for Remeasurement/Translation of Local Currencies

Let’s look at an example.