A U.S. company (functional currency USD) has a subsidiary in Brazil (functional currency BRL). The subsidiary reported BRL 1,000,000 in net income. During the period, the average exchange rate was 1 USD = 5 BRL, and the current exchange rate at period-end was 1 USD = 5.2 BRL. The company uses the temporal method for translation. What will be the translated net income in USD?
- AUSD 185,185
- BUSD 192,308
- CUSD 200,000
- DUSD 208,000
Show answer & explanationAnswer & explanation
Correct answer: C. USD 200,000
Under the temporal method, income statement items that relate to non-monetary assets and liabilities are translated at historical rates, while other income statement items are translated at the average rate. Since net income is generally considered to be composed of revenues and expenses that occur throughout the period, it is typically translated at the average exchange rate for the period. Therefore, Net Income = BRL 1,000,000 / 5 BRL/USD = USD 200,000.
Why the other options are wrong
- A. This is 1,000,000 / 5.4 (hypothetical rate), not based on the provided rates or method.
- B. This would be 1,000,000 / 5.2, using the current rate, which is incorrect for income statement items under the temporal method (unless specific items were at current rate).
- D. This implies an appreciation of BRL, which is incorrect as BRL weakened against USD (more BRL per USD). This might be 1,000,000 * 0.208, which is an incorrect application of rates.
Temporal Method Translation
A method of translating foreign subsidiary financial statements when the foreign subsidiary's functional currency is the same as the parent's reporting currency, or when the foreign economy is highly inflationary.
- Monetary Assets/Liabilities: Current Rate
- Non-Monetary Assets/Liabilities: Historical Rate
- Income Statement: Average Rate (most items), Historical Rate (depreciation/COGS)
- Translation Adjustments: Income Statement (translation gain/loss)
Memory trick: Temporal for Times, Monetary Now, Non-Monetary Then.