Beruflich Dokumente
Kultur Dokumente
An Example
1 Preliminary Statements
Table 1 provides the balance sheets as of December 31, 2001, and December 31, 2002,
for Pacotilles du Rhône, Inc., (PRI), a French subsidiary of a U.S. corporation. PRI has
been acquired on December 31, 2001, time at which the exchange rate was $0.89068/E. The
exchange rate on December 31, 2002, was $1.04862/E, and the average exchange rate for 2002
was $0.94486/E (these values come from http://pacific.commerce.ubc.ca/xr/data.html).
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Pacotilles du Rhône, Inc.
2002 Income Statement
(in millions of E)
Revenues 1,290
Cost of goods sold (540)
Other expenses (414)
Depreciation expense (210)
Net income 126
For the balance sheet, the current-rate method translates all assets and all liabilities at
the exchange rate in effect on the balance sheet date. That is, all assets and liabilities on the
2001 balance sheet have been translated at the rate $0.89068/E, and all assets and liabilities
on the 2002 balance sheet have been translated at the rate $1.04862/E. All equity items are
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translated at their historical rate. Since no common stock is issued in 2002, the rate used
to translate common stock in each year is the rate in effect on December 31, 2001, which
is $0.89068/E. This gives E230 × $0.89068/E = $205. For retained earnings, the amount
on the 2001 balance sheet is translated at the December 31, 2001, exchange rate, which
gives E504 × $0.89068/E = $449. The change in retained earnings has to be consistent
with the income statement, so accumulated retained earnings for 2002 are 449 + 120 = $569.
Imbalances due to translation are recorded in a different account, the cumulative translation
adjustment (CTA) account. Since all the 2001 balance sheet items are translated at the
same rate, there is no need for adjusment and thus the CTA account shows a zero balance
in 2001. On the other hand, since the 2002 balance sheet items are not all translated at the
same rate, the CTA account shows a positive balance in 2002 due to the euro appreciation.
The translated balance sheets are depicted in Table 4.
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2.1 Calculating the Translation Gain (Loss)
Let Si and S̄i denote the exchange rate (in home currency per foreign currency) on year i’s
balance sheet and the average exchange rate during year i, respectively, and let N Ai = Ai −Li
and ∆N Ai,i+1 denote net assets in year i’s balance sheet and the change in net assets from
year i to year i + 1, respectively. Under the current-rate method, the translation gain for
year i, denoted T Gi , is given by
T Gi = Si − Si−1 N Ai−1 + Si − S̄i ∆N Ai−1,i .
Note that this gives the change in CTA, not the CTA balance, except for the first year of
operations. The translation gain in the present example is
T G2002 = S2002 − S2001 N A2001 + S2002 − S̄2002 ∆N A2001,2002
= 129.
(i) Fixed Assets Fixed assets are translated at their historical rate. For fixed assets in
the Dec. 31, 2001, balance sheet, this gives
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For fixed assets in the Dec. 31, 2002, balance sheet, net new investments in 2002 are
translated at the average exchange rate for that period, which gives
E880 × $0.89068/E + (E1, 280 − E880) × $0.94486/E = $784 + $378 = $1, 162.
| {z }
net investment
(ii) Depreciation Depreciation expense in 2002 consists of the depreciation of assets ac-
quired on Dec 31, 2001, and depreciation of assets acquired during 2002. The exchange
rate used for 2002 depreciation expense is then a weighted average of the exchange rates
used for fixed assets, sometimes called “blended rate”. This rate is obtained as follows:
(iii) COGS In 2002, COGS is E540. From this amount, E195 was taken from the firm’s
inventory on Dec. 31, 2001, which is translated at the rate $0.89068/E, and 540−195 =
E345 has been purchased in 2002, which is translated at the average exchange rate for
the period, i.e. $0.94486/E. Translated 2002 COGS is then
(iv) Inventory 2001 inventory is translated at its historical rate, which is $0.89068/E in
this case, and thus
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Given the inventory on Dec. 31, 2001, the inventory on Dec. 31, 2002, and the 2002
COGS, we can find 2002 purchases as follows:
(v) Retained Earnings Under the temporal method, accumulated retained earnings in-
clude any imbalance from the balance sheet, and thus the income statement has to
be adjusted such that the difference between the 2002 accumulated retained earnings
and the 2001 accumulated retained earnings is consistent with the net income on the
translated income statement. The difference between translated accumulated retained
earnings being
545 − 449 = $96,
The 2002 income statement and the 2001-2002 balance sheets translated using the tem-
poral method are depicted in tables 5 and 6.
As before, let Si and S̄i denote the exchange rate (in home currency per foreign currency)
on year i’s balance sheet and the average exchange rate during year i, respectively, and let
N M Ai = M Ai − M Li and ∆N M Ai,i+1 denote net monetary assets in year i’s balance sheet
and the change in net monetary assets from year i to year i + 1, respectively. Under the
temporal method, the translation gain for year i, denoted T Gi , is given by
T Gi = Si − Si−1 N M Ai−1 + Si − S̄i ∆N M Ai−1,i .
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In the present example, we have
T G2002 = S2002 − S2001 N M A2001 + S2002 − S̄2002 ∆N M A2001,2002
= −$41.
Note that we have a translation loss under the temporal method, whereas the current-rate
method gave us a translation gain. This arises because there are more assets than liabilities
but less monetary assets than monetary liabilities.
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Pacotilles du Rhône, Inc.
2001 and 2002 Balance Sheets, Temporal Translation
Assets Liabilities and Owners’ Equity
2001 2002 2001 2002
Cash 48 199 Payables 245 325
Receivables 285 451 Current Debt 116 157
Inventory 174 227 Long-term debt 142 482
Current assets 507 877 Total liabilities 503 964
Fixed assets 784 1,162 Common stock 205 205
Accum. depr. (134) (325) Ret. earnings 449 545
Net fixed asset 650 837 Total equity 654 750
Total 1,157 1,714 Total 1,157 1,714