In a sample CFAI exam I came across a question asking how unrealized exchange rate holding gains are reflected in financial statements for CURRENT rate method. I thought that unrealized gains/losses never make it to B/S, so these could be ignored but the answer says “All gains and losses are reported as a cumulative translation adjustment in equity when the all-current method is used.”
Similarly for Temporal method, it says that unrealized non monetary gains are to be ignored but all other are considered.
I am really confused as to why unrealized gains/losses are considered in Current Rate? and why not in Temporal?
Current method is applicable when foreign currency is the functional currency of the subsidiary, the only time the Parent will have ‘economic’ exposure to foreign gain/loss when it sells this subsidiary and brings backs the proceeds of this sale to its
On the other hand, temporal is used when the parent’s functional currency is subsidiary functional currency, so essentially this foreign subsisidiary is running its day-to-day operations in parent’s currency while it continues to maintain its books in foreign currency (for tax reporting etc…purposes). So each month/quarter/year, the parent has a ‘real exposure’ to foreign exchange gain/loss which needs to be relfected in Parent’s IS.
When using the current rate method, the balance sheet, specifically, other comprehensive income under equity, is where the cumulative translation adjustment goes. If there is a net asset exposure, (Assets minus liabilities) and an appreciating foreign currency, there is an exchange rate gain, and equity goes up via the cumulative translation adjustment.
When using the temporal method, the foreign currency gain/loss goes on the income statement. The exposure under the temporal method will be either a net monetary asset, or a net monetary liability.