Question

Please read the statement, identify the problem that a MNC would face in operating in a global environment and make recommendations to remedy the problem

The Describe the two methods for the translation of foreign subsidiary financial statements into the parent company's consolidated statements. Identify when each technique should be used and the major advantage(s) of each.

Answer 1

Two methods for the translation of foreign subsidiary financial statements into the parent company's consolidated statements are: (i): current rate method (ii): temporal method.

The situation where each technique is used and major advantages are discussed below:

Current rate method is used when the subsidiary is not well integrated with the parent company. For using the current method the local currency of the country in which the subsidiary has operations has to be same as its functional currency. In this method all assets and liabilities are translated using the current exchange rates. The advantage of using the current rate method is that the gain or loss on translation does not pass through the income statement. As such the income statement remains unaffected as the gain/loss goes to a reserve account.

Temporal method is used when the local currency of the subsidiary is not the same as the currency of the parent company. As such differing exchange rates are used and this depends on the financial statement that is being translated. In this method specific assets are translated at exchange rates that are consistent with the timing of that asset’s creation. The advantage of this method is that it is aligned with valuation basis utilized in accounting. As such the numbers have a consistent internal relevance.