Temporal vs All-Current Methods

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maratikus

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it’s my weakest topic, for some reason can’t retain info. Let’s have a discussion in this thread.
I’ll start with determining which method to use. If local currency is the functional currency, all-current method is used (translating from functional currency to reporting currency), otherwise temporal method (remeasuring to functional currency).
I’d like to discuss which rate (historical, average, current) should be used for different elements of balance sheet and income statement and how ratios can be compared depnding on appreciation or depreciation of local currency.
 
For the most part, both methods use the average rate for the income statement. The temporal method uses a mixed rate for COGS and Depreciation. Dividends use the rate given.
All balance sheet items are translated at the current rate when using the All Current Method except for equity which is translated at the historical rate.
 
REMEMBER TO USE TEMPORAL WHEN HYPERINFLATION EXISTS !!
I have a feeling this could be a trap on exam day.
Hyperinflation, for sake of the exam, is a three year cumulative inflation of 100% or more.
 
Exposure
All Current: Equity (A-L)
Temporal: (AR + Cash) - (AP + Short & Long Term Debt)
 
Maratikus,
These are notes I made from the Solutions from Stalla Lecture for this topic. Might help someone out.
1. Factors in choosing a “functional currency” is determined by:
a. Market where Sales occur
b. Sources of Raw Materials
c. Sources of Financing.
If transactions occur mostly in Local Currency – then the Local Currency is the Functional Currency.
ALL CURRENT
==========
1. Financial Statements are prepared in a Functional Currency, DIFFERENT from the Local Currency.
2. Environment is NOT hyperinflationary ( > 100% over a 3 year period).
Remember to use CUMULATIVE Compounding : 1.1 * 1.2 * 1.2 - 1
3. Company is Self contained and Independent.
Start with the Income Statement and then move to the Balance Sheet.
Income Statement: Use Weighted Average Exch. Rate.
Balance Sheet: Assets, Liabilities are translated at the CURRENT Exchange Rate.
Only exceptions;
Capital Stock / Contributions: Use Date of Issuance Exch Rate.
Retained Earnings : R/E End = R/E Beginning + NI - Dividends.
Cumulative Translation Adjustment: Reported as a component of Shareholder’s equity.
It is treated as Unrealized Gains / Losses (PLUG value).
TEMPORAL METHOD:
===============
-> When Functional Currency of Foreign Subsidiary is determined to be the Parent’s reporting Currency.
-> When subsidiary is deemed to be an Integrated part of parent (like a Sales Outlet)
OR when environment is Hyperinflationary (> 100% over 3 years, cumulative compounded).
Requires Inventory, Fixed Assets and other Non-monetary accounts to be re-measured at the Historical Rates.
Balance sheet is divided into two portions:
Monetary: Cash, AR, Prepaid Expenses, Payables –> All measured at Current Exch. Rates.
Non-Monetary: PP & E, Inventory, Intangibles (Trademarks), Contrib. Capital –> measured at Historical Exch. Rates.
R/E is a PLUG.
Income Statement: Non-Balance sheet items and most expenses –> Measure at Wt. Avg. Exch. Rate (Same as in All-Current method).
Balance Sheet related expenses (COGS, Amortization, Depreciation) measured at Historical exch. rate. (Different from All-Current method).
Hope this helps you,
CP
 
Flow Effect mutiplier: (ending rate - average rate)
Holding Effect Multiplier: (ending rate - beginning rate)
 
cpk, very helpful notes
niblita and jbisback, thanks for your input
 
cpk123 - even without you studying for L2 a bit, you are going to nail this exam all over and be the curve decider for most of us here. You are the dude!!
 
cpk123 Wrote:
——————————————————-
> Maratikus,
>
> These are notes I made from the Solutions from
> Stalla Lecture for this topic. Might help someone
> out.
>
> ALL CURRENT
> ==========
> 1. Financial Statements are prepared in a
> Functional Currency, DIFFERENT from the Local
> Currency.
Isn’t All Current used when the Local Currency = Functional Currency. If Local Currency is DIFFERENT from the Functional Currency you would used the Temporal Method
 
i agree with mumukada’s statement. I was thinking about the same as I was reading the notes.
 
cpk123 Wrote:
> Income Statement: Use Weighted Average Exch.
> Rate.
> Current method
> Balance Sheet: Assets, Liabilities are translated
> at the CURRENT Exchange Rate.
> Only exceptions;
> Capital Stock / Contributions: Use Date of
> Issuance Exch Rate.
> Retained Earnings : R/E End = R/E Beginning + NI -
> Dividends.
> TEMPORAL METHOD:
> Requires Inventory, Fixed Assets and other
> Non-monetary accounts to be re-measured at the
> Historical Rates.
>
> Balance sheet is divided into two portions:
> Monetary: Cash, AR, Prepaid Expenses, Payables –>
> All measured at Current Exch. Rates.
> Non-Monetary: PP & E, Inventory, Intangibles
> (Trademarks), Contrib. Capital –> measured at
> Historical Exch. Rates.
>
> Income Statement: Non-Balance sheet items and most
> expenses –> Measure at Wt. Avg. Exch. Rate (Same
> as in All-Current method).
>
> Balance Sheet related expenses (COGS,
> Amortization, Depreciation) measured at Historical
> exch. rate. (Different from All-Current method).
Impact on ratios:
Since non-monetary assets (such as fixed assets) are reported at historical rate for temporal method and current rate for all-current method -> non-monetary assets are going to be lower for temporal method if local currency appreciates. For example, fixed asset turnover is going to be higher for temporal method if LC appreciates since since sales are reported at average rate (same for current and temporal) and current ratio is going to be higher lower for temporal method because inventory is recorded at historical rate.
 
Just to add to that something that helped me remember:
LC = Yen, parent company is in US.
2000 - Yen/USD = 100
2008 - Yen/USD = 120
Fixed assets purchased in 2000 are valued at Yen$1,000,000, equivalent to US$10,000
Value 2008::
All Current: US$8,333
Temporal: US$10,000
LC depreciated from 100 to 120.
 
why would interest coverage be higher under temporal method if LC appreciates?
 
Sales are reported at Average Rate.
The Interest Coverage ratio = EBIT / Interest Expense.
LC has appreciated.
So Interest expense would be Lower in terms of the Foreign currency (used for reporting purposes)
So interest coverage will be higher?
CP
 
Interet coverage would be higher under temporal because
Roughly, EBIT = Sales (using avg fx)- COGS(using historical) …leads to higher EBIT…
Interest Expense would be the same under both temporal and all current
 
anyone want to refresh me on how to get the CTA for all current? fuzzy. very fuzzy.
 
Hold Effect : Beg Exposure *(End Rate - Beg Rate)
Flow Effect: (End Exposure - Beg Exposure) * (End Rate - Avg Rate)
CTA = Hold Effect + Flow Effect
Exposure = Net Assets or (Total Assets - Total Liabilities)
Rates are in Parent Currency/Local Currency
 
mumukada Wrote:
——————————————————-
> Hold Effect : Beg Exposure *(End Rate - Beg Rate)
> Flow Effect: (End Exposure - Beg Exposure) * (End
> Rate - Avg Rate)
> CTA = Hold Effect + Flow Effect
>
> Exposure = Net Assets or (Total Assets - Total
> Liabilities)
> Rates are in Parent Currency/Local Currency
That exposure number is only for the all current method.
Exposure under temporal is (Cash + Accounts Recievable) - (Accounts Payable + Long-term Debt + Short Term debt)
 
^^ yes…I know..I was responding to the post by bannisja asking for the CTA for all current method :)
 
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