Page 182 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

Unit 11: Management of Translation Exposure

The two main advantages of the current rate method are, first, the relative proportions of the Notes
individual balance sheet accounts remain the same and hence do not distort the various balance
sheet ratios like the debt-equity ratio, current ratio, etc. Second, the variability in reported
earnings due to foreign exchange gains or losses is eliminated as the translation gain/loss is
shown in a separate account – the CTA account.

Did u know? The main drawback of the current rate method is that various items in the
balance sheet which are recorded at historical costs are translated back into dollars at a
different rate.
11.1.2 The Monetary/Non-monetary Method

The monetary/non-monetary method differentiates between monetary and non-monetary items.
Monetary items are those that represent a claim to receive or an obligation to pay a fixed
amount of foreign currency unit, e.g., cash, accounts receivable, current liabilities, accounts
payable and long-term debt.
Non-monetary items are those items that do not represent a claim to receive or an obligation to
pay a fixed amount of foreign currency items, e.g., inventory, fixed assets, long-term investments.
According to this method, all monetary items are translated at the current rate while
non-monetary items are translated at historical rates.
Income statement items are translated at the average exchange rate for the period, except for
items such as depreciation and cost of goods sold that are directly associated with non-monetary
assets or liabilities. These accounts are translated at their historical rates.

11.1.3 Temporal Method

This method is a modified version of the monetary/non-monetary method. The only difference
is that under the temporal method inventory is usually translated at the historical rate but it can
be translated at the current rate if the inventory is shown in the balance sheet at market values.
In the monetary/non-monetary method inventory is always translated at the historical rate.

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Caution Under the temporal method, income statement items are normally translated at
an average exchange rate for the period. However, cost of goods sold and depreciation are
translated at historical rates.

11.1.4 Current/Non-current Method

The current/non-current method is perhaps the oldest approach. No longer allowable under
generally accepted accounting practices in the United States, it was nevertheless widely used
prior to the adoption of FAS #8 in 1975. Its popularity gradually waned as other methods were
found to give more meaningful results. Under the current/non-current method, all current
assets and current liabilities of foreign affiliates are translated into the home currency at the
current exchange rate while non-current assets and non-current liabilities are translated at
historical rates.

In the balance sheet, exposure to gains or losses from fluctuating currency values is determined
by the net of current assets less current liabilities. Gains or losses on long-term assets and
liabilities are not shown currently. Items in the income statement are generally translated at the
average exchange rate for the period covered. However, those items that relate to revenue or

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