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FASB 52 – Foreign Currency Translation
Remeasurement
Also referred to as
Temporal Method
Criteria for use
Used when accounting records
are not kept in the functional
currency and for highly
inflationary functional currencies
Description
No attempt is made to preserve
relationships that exist in foreign
unit’s financial statements. The
object is to remeasure
nonmonetary assets at historical
currency exchange rates. The end
result may bear little relationship
to the foreign currency statements
used by local management
International useage
Temporal method or the
monetary/nonmonetary method is
used by nearly 50% of countries.
No major countries use the
current/noncurrent method.
Translation
Current Method
Used when accounting records
are kept in the functional currency
(as long as that currency is not
considered highly inflationary)
Foreign entity is viewed as a
separate business. The only
“factual” financial statements are
those denominated in the foreign
currency. The translation process
should maintain the relationship
among variables (e.g., current
ratio, debt to equity).
Used by nearly 50% of countries
(including almost all of Western
Europe and Japan)
Translation gains and
losses
Reported in net income and
closed to retained earnings
General procedures
Uses historical rates for all
nonmonetary items
Current rate
U.S., U.K. and Canada are the
only 3 countries that use both the
current rate and the temporal
method (depending on
circumstances)
Included in comprehensive
income and accumulated in
owners’ equity as “accumulated
other comprehensive income”
Uses current rates for all balance
sheet items except owners’ equity
Current rate
Historical rate
Current rate
Historical rate
Historical rate
Average rate for year
Average rate for year
Average for purchases, historical
for beginning and ending
inventory
Historical
Average rate for year
Average rate for year
Average rate for year
Monetary
assets/liabilities
Nonmonetary
assets/liabilities
Stock (common,
preferred, additional
paid in capital, etc.)
Sales
Expenses
Cost of goods sold
Depreciation,
amortization
ForCurrTrans.doc Created by T. Gordon 02/15/16
Average rate for year
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Translation of Financial Statements Denominated in
a Foreign Currency
Conceptual issues:
1.
2.
Which exchange rate to use
a.
Does the exchange rate selected for a specific account result in a meaningful
dollar amount?
b.
Does the exchange rate selected for a specific account change the basis of
accounting in translation?
c.
When a change in the exchange rate has occurred, do the translated results reflect
the true economic impact of the change?
How to report the effect of changes in exchange rates
a.
Do the reported effects relate to day-to-day operations?
b.
Do the reported effects impact cash flows?
c.
Are the reported effects realized or unrealized in nature?
The economic impact of an exchange rate change depends on:
a.
The causes of the exchange rate change (i.e., foreign inflation, domestic inflation,
noninflationary factors)
b.
The nature of the foreign unit’s assets (i.e., the extent to which the assets are monetary
versus nonmonetary).
c.
The extent of debt financing relative to equity financing
Effects of Exchange Rate Changes (Pahler & Mori, 1997)
Translation method
used
Possible relevant
financial position
Temporal
Temporal
Current rate
Foreign currency
has strengthened
with respect to
domestic currency a
Favorable
Unfavorable
Favorable
Domestic currency
has strengthened
with respect to the
foreign currency b
Unfavorable
Favorable
Unfavorable
Net monetary asset
Net monetary liability
Assets exceed
liabilities
Current rate
Liabilities exceed
Unfavorable
Favorable
assets
a
In all situations, the effect is favorable on assets and unfavorable on liabilities
b
In all situations, the effect is unfavorable on assets and favorable on liabilities
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The “Disappearing Plant” Problem
Many countries suffer from high inflation, sometimes exceeding 1000% per year. Using the
current rate method in such situations causes meaningless fixed asset situations. For example,
assume the parent spent $2,000,000 in 1974 to build a plant in Argentina when $2,000,000
purchased 10,000,000 pesos.
December 31, 1974
December 31, 1995
Amount
Rate
Amount
Rate
Amount
(pesos)
Plant
10,000,000
$.20
$2,000,000
$.00000001
$0.10
To make this work out to a sensible number, you would have to use price-level adjusted
statements instead of historical cost statements for the foreign unit, but this is not permitted
under U.S. GAAP.
History
Between 1930 and 1975 (FASB #8), U.S. companies generally used the current-noncurrent
method. In other words, current accounts were translated using current exchange rates and
noncurrent accounts were translated using historical exchange rates. This method has very shortterm focus – as though the U.S. company might need to take the working capital out of the
foreign operations at any time.
In 1975, FASB issued SFAS #8 which required the temporal method. Industry was furious over
the variability in earnings caused by this method and put FASB under tremendous pressure to
find a politically acceptable improvement to FASB #8. Floating exchange rates were “new”
when SFAS #8 came out.
In 1981, FASB issued SFAS #52 which allowed the current rate method to be used in many
cases and let most exchange rate gains and losses bypass the income statement. FASB also
invented the “functional currency” notion but the guidelines are vague enough that companies
can pretty much choose whether to use current rate method or the temporal method. FASB 52
has been more acceptable primarily because domestic inflation has not been high relative to
foreign inflation since 1981. If domestic inflation returned to the 1978-1981 levels, the current
rate method would have industry again clamoring for change!
In other words, both FASB #8 and FASB #52 are flawed because FASB did not properly
diagnose the causes for exchange rate changes (Pahler & Mori, 1997, p. 713).
Function currency idea
The functional currency idea is based on the contention that economic exposure is different for
autonomous foreign units as compared to nonautonomous foreign units. Pahler and Mori (1997,
p. 678) argue that the idea is “artificial, irrelevant, and misguided.
ForCurrTrans.doc Created by T. Gordon 02/15/16
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Foreign Currency Translation
Domestic currency unit of
measurement approaches
Variations
Current/noncurrent method
Monetary/nonmonetary method
Temporal method (FASB #8)
FASB terminology Remeasurement
Description
No attempt is made to preserve
relationships that exist in foreign
unit’s financial statements. The
object is to remeasure
nonmonetary assets at historical
currency exchange rates. The end
result may bear little relationship
to the foreign currency statements
used by local management
Matches ‘economic Works fairly well for highly
reality’
inflationary foreign currencies
Disappearing plant
problem
Useage
If domestic inflation rate is higher
than foreign inflation rate over a
period of time, foreign plant
values “shrink” to unrealistically
small numbers
Temporal method or the
monetary/nonmonetary method is
used by nearly 50% of countries.
No major countries use the
current/noncurrent method.
ForCurrTrans.doc Created by T. Gordon 02/15/16
Foreign currency unit of
measurement approach
Current rate approach
(general rule under FASB #52)
Purchasing Power Parity method
(PPP)
Translation
Foreign entity is viewed as a
separate business. The only
“factual” financial statements are
those denominated in the foreign
currency. The translation process
should maintain the relationship
among variables (e.g., current
ratio, debt to equity).
Focus on net asset position
(assumes all the foreign unit’s
assets and liabilities are exposed to
the risk of exchange rate changes).
Similar to current rate approach in
that one exchange rate is used but
foreign inflation is first taken into
consideration.
Properly deals with noninflationary causes of exchange
rate fluctuations
If foreign inflation rate is higher
than domestic inflation rate over a
period of time, foreign plant
values “shrink” to unrealistically
small numbers
Used by nearly 50% of countries
(including almost all of Western
Europe and Japan)
U.S., U.K. and Canada are the
only 3 countries that use both the
current rate and the temporal
method (depending on
circumstances)
Current value approach
“Best” portrayal of economic
reality
The method eliminates the
problem because changes in
relative inflation rates are taken
into account
None (?)
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Reporting Results for Specific Causes of Exchange Rate Change
(Based on Illustration 20-8 in Pahler & Mori, 1997, Advanced Accounting, 6th edition)
Assumed sole cause of
exchange rate change
Foreign inflation
Domestic inflation
Noninflationary factors
Offsetting foreign and
domestic inflation (no
net change)
Domestic inflation >
foreign inflation
Foreign inflation >
domestic inflation
Achieves “general compatibility” with the
economic effect of the exchange rate change
Current Rate Method
Temporal Method
No
Yes
Yes
No
Yes
No
No
No
ForCurrTrans.doc Created by T. Gordon 02/15/16
Reflects the “true economic effect” of the
exchange rate change
Current Rate Method
Temporal Method
No
Yes
Yes
No
Yes
No
No
No
Yes
No
No
No
No
Yes
No
No