Current Rate Method and Temporal Method: Effect of Currency Exchange Rate Movement on Financial Statements

Foreign currency strengthens relative to parent's presentation currency

	Current Rate Method	Temporal Method	Temporal Method
Exposure	Equity	Net Monetary Asset	Net Monetary Liability
Revenues	↑	↑	↑
Assets	↑	↑	↑
Liabilities	↑	↑	↑
Net income	↑	↑	↓
Shareholders' equity	↑	↑	↓
Translation loss/gain or Positive/negative translation adjustment	Positive translation adjustment	Translation gain	Translation loss

Foreign currency weakens relative to parent's presentation currency

	Current Rate Method	Temporal Method	Temporal Method
Exposure	Equity	Net Monetary Asset	Net Monetary Liability
Revenues	↓	↓	↓
Assets	↓	↓	↓
Liabilities	↓	↓	↓
Net income	↓	↓	↑
Shareholders' equity	↓	↓	↑
Translation loss/gain or Positive/negative translation adjustment	Negative translation adjustment	Translation loss	Translation gain

Foreign Currency Transaction Gains and Losses (reprise)

Foreign Currency Transaction Gains and Losses

Foreign Subsidiary's FC(*1)	Foreign Currency	Parent's PC (*2)
Translation Method (foreign subsidiary's bookkeeping currency→parent's PC(*2))	Current Rate Method	Temporal Method
Assets
Monetary (*3)	C (*4)	C
Nonmonetary; measured at current value	C	C
Nonmonetary; measured at historical cost	C	H
Liabilities
Monetary (*5)	C	C
Nonmonetary; measured at current value	C	C
Nonmonetary; NOT measured at current value (*6)	C	H
Equity
Other than retained earnings	H	H
Retained earnings	Beginning balance + Translated net income - Dividends translated at historical rate	Beginning balance + Translated net income - Dividends translated at historical rate
Revenue	A (*7)	A
Expenses
Most expenses	A	A
Expenses related to assets translated at historical exchange rate (*8)	A	H
Treatment of the translation adjustment in the parent's consolidated financial statements	Accumulated as a separate component of equity	Included as gain or loss in net income
When a foreign entity is located in a highly inflationary economy, the entity's functional currency is irrelevant in determining how to translate its foreign currency financial statements into the parent's presentation currency.	IFRS (*9) Cumulative 3-year inflation rate > 100%   or Cumulative 3-year inflation rate →(appoaching) 100%	U.S. GAAP (*10) Cumulative 3-year inflation rate > 100% ≈ (1+26%)^3-1

(*1) FC: Functional Currency
(*2) PC: Presentation Currency
(*3) e.g., cash; receivables
(*4) C: Currate Rate
(*5) e.g., account payable; accrued expenses; long-term debt; deferred income taxes
(*6) e.g., deferred revenue
(*7) A: Average rate
(*8) e.g., cost of goods sold; depreciation; amortization
(*9) (1) the financial statement of the foreign entity → restated for local inflation (2) the inflation-restated foreign currency financial statements → the parent's presentation currency
(*10) restatement for inflation is NOT allowed

Foreign Currency Transaction Gains and Losses

Foreign Currency Transaction Gains and Losses

	IFRS	U.S.GAAP
Foreign currency transaction (un)realized gains and losses	Net income(*)	Net income(*)

(*) as a component of

1. other operating income / expense or
2. nonoperating income / expense (e.g.) net financing cost

Foreign Currency Transaction Gains and Losses (B/S)

Foreign entity's	Curret rate method	Monetary / nonmonetary method	Temporal method
Common stock (Stockholder's equity)	H	H	H
Monetary assets (*3) Monetary liabilities (*4)	C (*1)	C	C
Nonmonetary assets (*5) Nonmonetary liabilities (*6)	C	H (*2)	Current value: C (*7)   or Historical cost: H (*8)
Presentation Currency	FC (*13)		FC
Functional Currency	FC ≠ Parent's PC(*9)		FC = Parent's PC (*15)
Revenue and Expenses	A (*10)		Exchange rates used to translate the related assets (*16)   or Average (*17)
Cumulative Translation Adjustment (*11)	Stochholders' equity		Net income (*18)
Net asset/liability balance sheet exposure	Net asset (*12)		Net asset   or Net liability
FC (*13) strengthen	Positive CTA(*14)↑ or Negative CTA ↓ due to positive TA
FC weakens	Negative CTA↑ or Positive CTA ↓ due to negative TA
One of IFRS/U.S.GAAP requirement?	Yes		Yes

(*1) C: Current exchange rate. The spot exchange rate on the balance sheet date.
(*2) H: Historical exchange rate. The exchange rate that existed when the assets and liabilities were acquired.
(*3) Cash and receivables that are received in a fixed number of current units.
(*4) Payables that are paid in a fixed number of current units.
(*5) Inventory, fixed assets, and intangibles.
(*6) Deferred revenue.
(*7) Nonmonetary assets and liabilities that are measured a their current value on the balance sheet date.
(*8) Nonmonetary assets and liabilities that are measured a their historical cost on the balance sheet date.
(*9) PC: Presentation Currency
(*10) A: Averate exchange rate
(*11) unrealized translation gain or loss; when a specific foreign entity is sold, the cumulative translation adjustment related to that entity is reported as a realized gain or loss in net income.
(*12) Total assets > Total liabilities → Net asset balance sheet exposure (except in the rare case of the foreign entity's negative stockholders' equity)
(*13) FC: Foreign Currency
(*14) CTA: Cumulative Translation Adjustment
(*15) FC → Parent's PC: remeasurement
(*16) Expenses related to nonmonetary assets (e.g. COGS for inventory, Depreciation for fixed assets, and Amortization for intangible assets)
(*17) Other than the ones above.
(*18) Remeasurement gains and losses

Net Pension Asset (Liability)

Net Pension Asset (Liability)

	IFRS	US.GAAP
Net Pension Asset (Liability; if negative)	Funded status(*) - Unrecognised actuarial gains + Unrecognised prior service costs (**)	Funded status(*)

(*) funded status = FV of plan assets - Pension benefit obligation
(**) adjust for (consider) all unrecognised items

Employee Stock Options

Employee Stock Options

Reported income	(3)Down	(3)Up	(3)Down	(3)Down
Compensation expense	(2)Up	(2)Down	(2)Up	(2)Up
Deferred compensation liability	-
Expected volatility	(1)Up
Dividend yield		(1)Up
Expected life			(1)Up
Risk free rate				(1)Up

-: No change/effect

Defined Benefit pension plan

Defined Benefit pension plan

	IFRS	U.S. GAAP
B/S	Funded status(*) - Unrecognised actuarial gains + Unrecognised actuarial losses + Unrecognised past service cost	Funded status
Different line items in I/S?	Yes	No

(*) Funded status = FV of plan assets - PV of DB obligation

Net income + Company's net periodic benefit cost (non-cash expense) - Company contributions = CFO

Service costs: estimated increase in the pension obligation resulting from employees' service during the period (and benefits earned by current employees).

Actual return on plan assets = Expected return on plan assets + Actuarial gains

Defined Benefit pension plan

Pension obligation	-	Down					Up
Expected long-term return on plan assets	Up / Down		Up			Down		Down
Discount rate		Up	Up		Down	Down
Interest cost		Down(*)
Net periodic cost (pension expense)	Down / Up	Down		Up				Up
Reported net income		Up	Up				Down	Down
CFO		-
Estimated future salary increases				Up(**)	Down		Up
Inflation				Up(**)
Recognised prior service costs							-
Net assets								-

(*) unless the pension obligation is of short duration
(**) normally
-: No change/effect

Defined Benefit Obligation

Discount Rate	Up
(future) pension expense	Down	Up	-
Benefit Obligation	Down	Up
Rate of compensation increase		Up
Actual return			> Expected return
Plan assets			Up

Defined Benefit Obligation

Expected return on plan assets	Up
Reported pension expense	Down	Down	Down
Interest cost component of the net periodic cost			Down(*)
Projected pension obligation	-	Down	Down
Compensation growth		Down
Net income		Up
FV of plan assets		-	-
Discount Rate			Up

(*) typically, except if the pension obligation is of short-term duration


Benefit obligation at end of year: total PV of all benefits (=future payments) employees have earned in the current and prior periods based on their service up until end of year, regardless of whether the benefits have vested.


Underlying economic pension expenses
= Benefit obligations (ending) - Benefit obligations (beginning) + Benefits paid
- (PV of plan assets (ending) - PV of plan assets (beginning) + Benefits paid - Employer's contribution)
= - (Funded status (ending) - Funded status (beginning) - Employer's contribution)

Joint Venture

Joint Venture

	pooling of interests	acquisition
Assets	historical BV	FV
Liabilities	historical BV	FV
Revenue	(No effect)	(No effect)

Special Purpose Entity (SPE)

Special Purpose Entity (SPE)

SPE	IFRS	US.GAAP
consolidated?	Yes, if SPEs are conducted for the benefit of the sponsoring company	If not qualifying SPEs
qualifying SPE	NOT allowed	Allowed
Revenuse	(No effect; reversed)
Cash	(No effect; reversed)
Accounts receivable	(No effect; reversed)

Investments in Financial Assets

Investments in Financial Assets

	CV(*)	Interest Income	Earning before taxes(t)	Amortization
Held-to-maturity	Amortized cost (****)	Yes		par value > initial cost -->positive interest income par value < initial cost -->negative interest income
Available for sale	MV(**)	Yes (***)
Held for trading	MV(**)	Yes	MV(t) - MV(t-1)

(*) Carrying Value
(**) Market Value
(***) When reclassified from held-to-maturity for a non-par bond, adjustment is required.
(****) Amortized cost = Historical cost = Par value, if historical cost is a par-value

Intercorporate Investments

See image:

Intercorporate Investments

	Investment in financial assets	Investment in associates	Joint Venture	Business Combination
influence/control	(None)	significant influence	joint control	control
method	Held-to-maturity[HTM] Available for sale[AFS] Held for trading[HFT]	Equity method	IFRS: Proportionate consolidation [pc] U.S.GAAP: Equity method [eq]	Acquisition
Goodwill				IFRS: full [FG],partial [PG] U.S.GAAP: full [FG]
Income Statement
Revenue (Sales)		(No change)	[pc] +share(%) [eq] (No effect);  reflected in a single line)	+100(%)
Cost of sales			[pc] +share(%) [eq] (No effect);  reflected in a single line)
Expenses			[pc] +share(%)  [eq] (No effect);  reflected in a single line)
Depreciation and amortization expenses			[pc] +share(%) [eq] (No effect);  reflected in a single line)	+100(%) +(e.g.)amortization of licese(*) (*) (Purchase price (for 100%) - Net Asset BV(for 100%))/Economic life
Earnings before taxes	[HTM] dividends [AFS] dividends [HFT] unrealized P&L + dividends
Net income	[HTM] dividends share(%) [AFS] dividends share(%)	+share(%)	[pc] +share(%) [eq] +share(%)	+100(%)
Balance Sheet
Current Assets		(No change)		+100(%)
Total Assets			[pc] +share(%) [eq]	+100(%) Assets -Cash paid for the purchase +Goodwill [FG] higher  [PG] lower
Debt		(No change)		+100% (usually BV=FV)
Current Liabilities		(No change)		+100(%)
Shareholders' equity		(No change)	[pc] +share(%) [eq] +share(%)	+Noncontrolling interest
Total Equity		(No change)		+Noncontrolling interest [FG] higher  [PG] lower