I’ve seen this question 20 times: Under the temporal method, if the the subsidiary’s currency is depreciating and and the subsidiary has a net liability exposure (monetary assets are less than monetary liabilities), this translates into a POSITIVE TRANSLATION ADJUSTMENT FOR THE PARENT… why?
You have a liability. You owe somebody 100 Euros. When you took the loan - 1 Euro was 1.5$. So you had to convert 150$ to Euros at the time you took the loan to pay it back. Now say 1 Euro=1.2$. You now have to convert only 120$ to Euros to pay back your loan. You are the Parent Company. Does that now make sense?
I understand the part about the subsidiary’s currency weakening but, what about the subsidiary’s net liability exposure (this q is all over Schweser book 6 and 7 sample exams)
you have more liabs than assets. so your exposure is a net liability. A-L is negative… (technically speaking your equity is negative).
Under the temporal method you use current rate for monetary A and L net liability exposure = monetary assets are less than monetary liabilities
Correction to cpk123’s second post - the equity is not necessarily negative, as the net liability in this case is monetary, not general - so monetary assets are less than monetary liabilities, but other assets and liabilities included there would most probably be a net asset exposure (few companies survive long in negative equity).
In case you are still confused on this one, just think of a simple example: say that a subsidiary has a net liability exposure of $20 (ie. monetary liabilities are $20 more than monetary assets) also assume theat the fx rate at t0 is 1FC/DC - then the parent would incure a $20 loss on their b/s after translating (assuming all A & L are monetary) @t1 the foreign currency depreciates so the fx rate is now 2FC/DC - now the parent only incures a $10 loss on their B/S after translating. The liability in the eyes of the parent went from oweing $20 to $10 just from the underlying change in exchange rate. therefore a positive translation adjustment.
This is what I’ve seen Temporal Method If subsidiary’s currency is depreciating & there is a net monetary liability, this translates into a gain for the parent (I think we have this pretty well worked out) Question: 1) What if the subsidiary has a net monetary liability, but the subsidiary’s currency appreciates, does this translate into a loss for the parent? 2) Also, what if the subsidiary’s currency depreciates, but the subsidiary has a net liability asset on its balance sheet, does this translate into a loss or gain for the parent?
- If the sub’s currency appreciates and there is a net monetary liability then since there are more liabilities that are being adjusted with the currency, the result is a negative translation adjustment for the parent. 2. if the sub’s currency depreciates and there is a net MONETARY asset (i assume that’s what is meant, I don’t know what a net liability asset is) then there is a negative translation adjustment.
thanks for the responses