The risk that a company’s financial statements, which include a company’s equities, assets, liabilities or income, will change in value as a result of exchange rate changes. A business has translation exposure when one companies’ assets or liabilities in a foreign currency needs to be translated back to its base currency for accounting purposes. (Translation exposure, n.d.)It also called accounting exposure, the potential way to translate financial statements of foreign subsidiaries into a reporting currency for consolidated financial statements. (Moffett, Stonehill, & Eiteman, 2012)
Many countries use the translation method by a foreign subsidiary based upon its business operation. For instance, the foreign subsidiary can be divided into an integrated foreign entity or a self-sustaining foreign entity. A foreign subsidiary’s functional currency is the current of primary economic environment in which the subsidiary can operate and generate cash flow. In short, it is common that the primary currency used foreign subsidiary to deal with its daily operations. The geographic location may be different. Management must access the nature and purpose of each individual foreign subsidiary to decide which functional currency is appropriate. If a foreign subsidiary of a Canadian-based company is determined to have the Canadian dollar as its functional currency, it is an extension of the parent company. However, if a different currency is determined to be as the functional currency, the subsidiary is considered as a separate entity from the parent. (Moffett, Stonehill, & Eiteman, 2012)
The current method currently is the most popular method. Most financial statement line items are translated at the current exchange rate under this method. The gains and losses caused by translation adjustments are not included in the calculation of consolidated net income. Instead, gains or losses are reported separately and accumulated in a separate account, named “cumulative translation adjustments” (VTA), but it depends on the country. These below items are translated at the current exchange rate,
Assets and liabilities
Income statement items, include depreciation and cost of goods sold.
Distributions, like dividends paid.
Equity items, like common stock and paid-in capital accounts. The temporary method requires assets and liabilities are translated at exchange rates which consistent with the timing of the item’s creation. Under the temporary method, some individual line item assets are indicated regularly to reflect market value. If there were not indicated, then retested at historical rate, it would be the monetary/nonmonetary method, which is a form of translation that is still adopted in some countries today. Items include the following: monetary assets and monetary liabilities are translated at current exchange rates, and nonmonetary assets and liabilities are translated at historic rates; Income statement items are translated at the average rate,