Translation methods

CFA Level II FRA
#1

Hi guys,

Hope you are doing well in your studies.

I reached to the translation methods of financial statements. Well, the official curriculum says the following: “Which method is appropriate for an individual foreign entity depends on that entity’s functional currency.” and then no explanation which method (current rate vs temporal) is appropriate for an individual foreign entity. At least I didn’t find/grasp.

Could someone be kind to shade some light here? Thanks beforehand.

#2

I guess I’ve just grasped the answer.

The current rate method is used when the subsidiary’s functional currency is different from the parent’s functional currency. The temporal method is used when the subsidiary’s functional currency is the same as the parent’s functional currency.

Correct me if I am mistaken or in case I miss something important.

#3

No, you pretty much nailed it.

#4

Not quite.

There’s only one functional currency, not two.

The three currencies are:

  • Local currency: the currency of the subsidiary’s country
  • Functional currency: the currency of the primary business environment in which the subsidiary operates (which is often the same as the local currency, but not necessarily)
  • Presentation currency: the currency in which the parent presents its financial statements (which is often the same as the currency of the parent’s country, but not necessarily)

If the local currency is different from the functional currency, you use the temporal method to change from the local currency to the functional currency.

If the functional currency is different from the presentation currency, you use the current rate method to change from the functional currency to the presentation currency.

In the real world, you could have to do both. For example, you may have a Swiss subsidiary (local currency: CHF), operating in the Eurozone (functional currency: EUR), owned by a British company (presentation currency: GBP). Here, you would use the temporal method to change from CHF to EUR, then the current rate method to change from EUR to GBP.

On the exam, you won’t have to use both methods in a single question. So, on the exam, either the local currency will be the same as the functional currency, or else the functional currency will be the same as the presentation currency; in either case, the local currency will be different from the presentation currency.

#5

I am so thankful that level 2 is behind me along with all of FRA :slight_smile:

Good luck

#6

Now, if you could just get a handle on those pesky return requirements . . . .

#7

Almost there Bill :slight_smile:

#8

Thanks, S2000magician!

In other words, there are 2 main steps in translation of financial statements. 1) from local currency to functional currency (temporal method), 2) from functional currency to presentation currency (current rate method).

If the local currency is the functional currency, there is no need for the first step. If the functional currency is the presentation currency, there is no need for the second step.

I missed an important point. Now, I can hardly forget this material since I understand it instead of learning by heart, thanks to you.