Question

Johnson Controls Corp., a major U.S. auto parts supplier, has a manufacturing subsidiary in Nuevo Laredo, Mexico, which assembles wiring harnesses for auto electrical systems. Quarterly, Johnson Controls must consolidate the financial statements of all its foreign subsidiaries into one overall corporate-wide financial statement as required by U.S. accounting standards. This results in translation gains and losses as exchange rates fluctuate against the U.S. dollar. The Mexican peso has been particularly volatile the last few years so the Treasurer of Johnson Controls has been following the translation exposure of the Mexican subsidiary with unusual interest. Prepare the Translation Exposure Report by both the current rate and temporal methods from the balance sheet information for the Mexican subsidiary presented below (all accounts are in pesos 000’s).

Assets                                                               Liabilities                                  

Cash                             Ps 5400                         Accounts Payable                                    Ps 4600

Accounts Receivable             8750                         Bank loans                                    13800

Inventory                             12860                         Bonds                                           8370

Plant & Equipment              25430                        Common Stock                              24000

                                                                        Retained Earnings                            1670

1. If the exchange rate is Ps 14.2650/$ at the end of the next quarter, what would be the translation gain or loss by the a. current rate method and b. temporal method?
2. If the exchange rate is Ps 16.8455/$ at the end of the next quarter, what would be the translation gain or loss by the a. current rate method and b. temporal method?            

Answer 1

Current Rate Method

Under this method, all assets and liabilities are translated using the current exchange rate. Common Stock is translated using historical rate and Retained earnings are translated using the rate on the day dividends were declared ( if any ). We’ll assume that to be the balance sheet date.

Current rate is given as Ps 15.6432/ $

Under Current rate method, we have the following translation of the provided accounts:

	Exchange rate	Ps 15.6432/ $
Assets ( in 000's Mexican Pesos)		Translated Assets ( in 000's USD)
Cash	5400	345.1979135
Accounts Receivable	8750	559.3484709
Inventory	12860	822.0824384
Plant & Equipment	25430	1625.62647
Liabilities (in 000's Mexican Pesos)		Translated Liabilities (in 000's USD)
Accounts Payable	4600	297.4804698
Bank Loans	13800	892.4414093
Bonds	8370	541.2851156
Common Stock	24000	1552.072016
Retained Earnings	1670	107.9983445

Please note that Common stock is translated using the historical rate. As there is no such rate given here, we assume that historical rate ( the rate when common stock was floated by the company ) is same as the current rate.

Temporal Method

Under this method those assets that are measured at cost under the lower of cost or Market rule are measured at historical rates. Only Property, Plant and Equipment in the given question falls under that asset category. For Liabilities, only those liabilities that are not measured at current value ( like deferred revenue) are translated at historical costs. We have no such liability here. Therefore, all liabilities are translated using the current rate. Because no historical rate info has been given, I’ll use temporal method for translation of accounts in the subsequent quarter. The assumption is that the Peso accounts remain unchanged and only the exchange rate has changed. 15.6432/ $ is the historical rate now and 14.2650/ $ is the current rate.

We have the following translation under temporal method for the next quarter:

	Historical Exchange rate	Ps 15.6432/ $
	Current Exchange Rate	Ps 14.2650/ $
Assets ( in 000's Mexican Pesos)		Translated Assets ( in 000's USD)
Cash	5400	378.5488959	Current Rate
Accounts Receivable	8750	613.3894147	Current Rate
Inventory	12860	901.5071854	Current Rate
Plant & Equipment	25430	1625.62647	Historical Rate
Liabilities (in 000's Mexican Pesos)		Translated Liabilities (in 000's USD)
Accounts Payable	4600	322.467578	Current Rate
Bank Loans	13800	967.402734	Current Rate
Bonds	8370	586.7507886	Current Rate
Common Stock	24000	1552.072016	Historical Rate
Retained Earnings	1670	107.9983445	Historical Rate
	Total Assets	3519.071966
	Total Liabilities and Stockholder's Equity	3536.691461
	Translation Gain/Loss	-17.61949494

As you can observe fron the Table,

Translation Loss from the translation is equal to $17.619