Translation and Consolidation of Foreign Subsidiary Financials Using the Current Rate Method

Introduction

When a multinational corporation operates in multiple countries with different currencies, it must address the complexities of currency fluctuations in its financial reporting. The current rate method is a commonly used technique to translate the financial statements of a foreign subsidiary into the reporting currency of the parent company. In this essay, we will delve into the application of the current rate method by using the case of San Clemente Corporation, whose functional currency is the Mark (M), and its foreign subsidiary’s functional currency is the Peseta (P).

Translating Financial Statements

Cash: The subsidiary’s cash balance of P6,000 on December 31, Year 1, needs to be translated into Marks using the exchange rate prevailing on that date, which is 0.65M per 1P. The translated cash balance is 6,000 P * 0.65M/P = 3,900M.

Accounts Receivable: Similarly, the accounts receivable balance of P10,000 is translated using the December 31 exchange rate. The translated balance is 10,000 P * 0.65M/P = 6,500M.

Equipment: The equipment balance of P12,000 is also translated using the December 31 exchange rate. The translated balance remains the same as the functional currency is already Peseta.

Accumulated Depreciation: The accumulated depreciation balance is not translated because it’s a contra-asset account.

Land: The land balance of P30,000 is translated using the December 31 exchange rate. The translated balance is 30,000 P * 0.65M/P = 19,500M.

Accounts Payable: The accounts payable balance is not translated because it’s a liability account.

Note Payable: The note payable balance is also not translated as it’s a liability.

Common Stock: The common stock balance is not translated because it’s an equity account.

Dividends: The dividends balance is not translated as it’s an equity distribution.

Sales: The sales revenue of P40,000 is translated using the weighted average exchange rate for Year 1, which is 0.67M per 1P. The translated sales revenue is 40,000 P * 0.67M/P = 26,800M.

Salary Expense: The salary expense of P15,000 is also translated using the weighted average exchange rate. The translated salary expense is 15,000 P * 0.67M/P = 10,050M.

Depreciation Expense: The depreciation expense is not translated because it’s an accounting entry and not an actual cash flow.

Other Operating Expenses: The other operating expenses of P9,000 are translated using the weighted average exchange rate. The translated expenses are 9,000 P * 0.67M/P = 6,030M.

Calculation of Translation Adjustment

The translation adjustment reflects the impact of changing exchange rates on the equity of the subsidiary. It is the difference between the translated equity and the equity calculated using the historical exchange rate. In this case, we will calculate the translation adjustment for common stock, retained earnings, and net income.

Common Stock: The common stock balance is not subject to translation adjustment.

Retained Earnings (Net Income):

Net Income = (Sales – Salary Expense – Depreciation Expense – Other Operating Expenses) = (40,000 P – 15,000 P – 3,000 P – 9,000 P) = 13,000 P

Translated Net Income = 13,000 P * 0.67M/P = 8,710M

Historical Net Income = 13,000 P * 0.71M/P = 9,230M

Translation Adjustment for Net Income = Historical Net Income – Translated Net Income = 9,230M – 8,710M = 520M

Retained Earnings (Beginning Balance):

Beginning Retained Earnings = 0 (Assuming this is the beginning of the subsidiary’s operations)

Translated Beginning Retained Earnings = 0

Retained Earnings (Ending Balance):

Ending Retained Earnings = Beginning Retained Earnings + Translated Net Income – Dividends = 0 + 8,710M – 10,000 P = -1,290M

Translated Ending Retained Earnings = -1,290M * 0.65M/P = -838.5M

Translation Adjustment:

Translation Adjustment = Translated Ending Retained Earnings – Translated Beginning Retained Earnings = -838.5M – 0 = -838.5M

Conclusion

:In this essay, we have explored the application of the current rate method in translating the financial statements of a foreign subsidiary into the reporting currency of the parent company. Through this process, we have calculated the translated balances of various accounts, as well as the translation adjustment, which represents the impact of changing exchange rates on the equity of the subsidiary. The current rate method enables multinational corporations like San Clemente Corporation to present accurate and meaningful consolidated financial statements, facilitating better decision-making and financial analysis.