How does the all-current method for foreign currency translation work with a comprehensive example?
I'm studying multinational operations for CFA Level II and the all-current method seems straightforward in theory, but I keep getting the translation adjustment wrong in practice. Can someone walk through a complete example showing the balance sheet, income statement, and cumulative translation adjustment?
The all-current method (also called the current rate method) is used when the foreign subsidiary's functional currency is the local (foreign) currency. This means the subsidiary operates relatively independently from the parent.
Translation rules:
| Item | Exchange Rate Used |
|---|---|
| Assets | Current rate (balance sheet date) |
| Liabilities | Current rate (balance sheet date) |
| Common stock | Historical rate (date of investment) |
| Revenue & expenses | Average rate for the period |
| Dividends | Rate on date of declaration |
Comprehensive Example:
Calverton Corp (US parent) owns 100% of Lisbon Tech (Portuguese subsidiary). Lisbon Tech's functional currency is the Euro. Exchange rates:
| Rate | EUR/USD |
|---|---|
| Historical (investment date) | 1.15 |
| Beginning of year | 1.10 |
| Average for year | 1.08 |
| End of year (current) | 1.05 |
| Dividend declaration date | 1.07 |
Lisbon Tech Income Statement (in EUR):
| Item | EUR | Rate | USD |
|---|---|---|---|
| Revenue | 5,000,000 | 1.08 (avg) | $5,400,000 |
| COGS | (3,000,000) | 1.08 (avg) | ($3,240,000) |
| Depreciation | (400,000) | 1.08 (avg) | ($432,000) |
| Other expenses | (800,000) | 1.08 (avg) | ($864,000) |
| Net income | 800,000 | $864,000 |
Lisbon Tech Balance Sheet (in EUR):
| Item | EUR | Rate | USD |
|---|---|---|---|
| Cash | 1,200,000 | 1.05 (current) | $1,260,000 |
| Receivables | 800,000 | 1.05 | $840,000 |
| Inventory | 1,500,000 | 1.05 | $1,575,000 |
| PP&E (net) | 3,500,000 | 1.05 | $3,675,000 |
| Total assets | 7,000,000 | $7,350,000 | |
| Accounts payable | 600,000 | 1.05 | $630,000 |
| Long-term debt | 2,000,000 | 1.05 | $2,100,000 |
| Common stock | 2,400,000 | 1.15 (historical) | $2,760,000 |
| Retained earnings | 2,000,000 | (see below) | $2,088,000 |
| CTA (plug) | — | — | ($228,000) |
| Total L + E | 7,000,000 | $7,350,000 |
Retained earnings calculation:
- Beginning RE (translated): $1,424,000
- Plus net income (translated): $864,000
- Less dividends (200,000 EUR x 1.07): ($200,000 x 1.07) = ($214,000)
- Ending RE: $2,074,000 (I am using simplified figures for illustration)
The CTA is the plug that makes the balance sheet balance after translating assets and liabilities at the current rate but equity at historical/mixed rates. It appears in accumulated other comprehensive income (AOCI) on the consolidated balance sheet.
Key analytical points:
- Net asset exposure: Under the all-current method, if a subsidiary has net assets in a depreciating currency, the CTA will be negative (translation loss)
- Revenue and expense impact: A weakening foreign currency reduces translated revenue and expenses
- The CTA is only recognized in P&L upon disposal of the subsidiary
Exam tip: CFA Level II commonly asks you to calculate a specific translated line item or the CTA. Remember: all assets and liabilities at current rate, equity at historical, income statement at average, and CTA is the balancing figure in equity.
For more translation method practice, visit our CFA Level II question bank.
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