CPA Exam - FAR (Financial Accounting and Reporting)Select TransactionsEasy
A company, a U.S. parent, has a subsidiary operating in a foreign country. The subsidiary's functional currency is its local currency, which is different from the U.S. dollar. At year-end, the subsidiary's assets and liabilities are translated into U.S. dollars for consolidation purposes. Which of the following exchange rates should be used to translate the subsidiary's plant and equipment?
- AThe current exchange rate at the balance sheet date.
- BThe exchange rate at the date the assets were placed in service.
- CThe historical exchange rate at the date of acquisition.
- DThe average exchange rate for the period.
Show answer & explanationAnswer & explanation
Correct answer: A. The current exchange rate at the balance sheet date.
When the functional currency is the foreign entity's local currency, the translation method (also known as the current rate method) is used. Under this method, assets and liabilities are translated using the current exchange rate at the balance sheet date.
Why the other options are wrong
- B. This is a distractor, historical cost is relevant for the asset's original value, but not the exchange rate for translation under the current rate method.
- C. Historical rates are used for equity accounts under the current rate method, not for assets and liabilities. This would be used for monetary assets and liabilities under the remeasurement method.
- D. Average rates are typically used for income statement items, not for balance sheet assets.
Foreign Currency Translation (Current Rate Method)
When a foreign subsidiary's functional currency is its local currency, assets and liabilities are translated at the current exchange rate, and equity accounts (like common stock) are translated at historical rates.
- Used when functional currency is the foreign entity's local currency.
- Assets and liabilities translated at current exchange rate.
- Equity accounts translated at historical exchange rates.
- Revenues and expenses translated at average exchange rate.
- Translation adjustments go to Other Comprehensive Income (OCI).
Memory trick: Current Rate Method: C.A.L.M. - Current for Assets/Liabilities, Average for Income, Historical for Equity, OCI for Translation.