Hi guys,
I am getting a bit confused with this table:
METHOD APPR OVERSEAS CURRENCY DEPR OVERSEAS CURRENCY
Net Monetary Assets Temporal GAIN LOSS
Net ASsets Current GAIN LOSS
Net Monetary Liabilities Temporal LOSS GAIN
I am struggling to work my head around what suits who when the domestic strengthens/weakens or the overseas strengthens/weakens.
Does anyone have an intuitive explanation with some basic examples?
Thanks
Hey Rex,
So the simplest way I’ve understood it is it all depends on what items on the balance sheet are translated at the current exchange rate, and ultimately whether there are more assets or liabilities translated at the current exchange rate.
In the case of the current rate method, all assets/liabilities are measured at the current rate. Since total assets translated at the current rate will be greater than the total liabilities translated at the current rate (almost always the case unless equity is negative), companies translating under the current rate method have a “net asset exposure.” An appreciating foreign currency where this net asset exposure is denominated means you can translate it for more at the current rate, as opposed to a historical rate, and will thus see a gain on the balance sheet by way of the cumulative translation adjustment (CTA).
In the case of the temporal rate method, the assets and liabilities typically measured at the current rate are the “monetary” assets/liabilities… so for assets this would be cash, A/R, marketable securities, and for liabs this would be AP, long-term debt, short term debt. Because companies’ monetary liabilities are typically greater than their monetary assets, they typically have a net monetary liability exposure where an appreciating currency will increase their translated net liabilities and result in a translation gain/loss arising in the income statement.
So in summary: it comes down to understanding which items are translated at the current rate, and then seeing if you have more assets or liabilities translated at that current rate to see if you’d have a net asset or net liability exposure. Once you’ve determined that, you just need to recall that a net asset exposure translated from a strengthening currency will produce gains, where they’d conversely produce losses if the foreign currency depreciated. In the case of net liability exposure, the opposite would hold true (i.e., an appreciating FC produces translation losses, and a depreciating FC will yield translation gains).
I really hope this helped you!
Black Mamba, heroic post bro. THank you v much!
No worries, heroic ftw.