CFA Level II ExamFinancial Statement AnalysisEasy
A U.S. company (functional currency USD) has a manufacturing subsidiary in a country whose currency is the Euro (EUR). The subsidiary's operations are largely self-contained, and it conducts most of its business in EUR. For consolidation purposes, which method should the U.S. parent company use to translate the subsidiary's financial statements?
- ACurrent rate method
- BMonetary/non-monetary method
- CEquity method
- DTemporal method
Show answer & explanationAnswer & explanation
Correct answer: A. Current rate method
Given that the subsidiary's operations are self-contained and its functional currency (EUR) is different from the parent's reporting currency (USD), the current rate method is the appropriate translation method for consolidation.
Why the other options are wrong
- B. The monetary/non-monetary method is an older term for the temporal method and is not typically used as a distinct method in current accounting standards.
- C. The equity method is an accounting method for investments, not a translation method for consolidating a subsidiary.
- D. The temporal method is used when the subsidiary's functional currency is the same as the parent's reporting currency or when the subsidiary operates in a highly inflationary economy.
Current Rate Method
A foreign currency translation method used when a foreign subsidiary's functional currency is different from the parent company's reporting currency.
- All assets and liabilities are translated at the current exchange rate.
- Equity accounts (except retained earnings) are translated at historical rates.
- Income statement items are translated at the average exchange rate.
- Translation adjustments are reported in Other Comprehensive Income (OCI).
Memory trick: Functional Currency Drives the Translation Choice.