What Is the Current Rate Method?
When a company has operations in other countries, it may need to exchange the foreign currency earned by those foreign operations into the currency used when preparing the company's financial statements—the presentation currency. The current rate method is utilized in instances where the subsidiary isn't well integrated with the parent company, and the local currency where the subsidiary operates is the same as its functional currency.
- The current rate method is a standard method of currency translation that utilizes the current market exchange rate.
- Currency translation is the process of converting the financial results of a parent company's foreign subsidiaries into its functional currency.
- Companies must report using the currency of the environment in which it primarily generates and expends cash.
- The current rate method is most often used when the subsidiary company is fairly independent of the parent's activities. It may be contrasted with the temporal method.
Understanding the Current Rate Method
Currency translation is the process of converting a foreign entity's functional currency financial statements to the reporting entity's financial statements.
The current rate method differs from the temporal (historical) method in that assets and liabilities are translated at current exchange rates as opposed to historical ones. This can create a high amount of translation risk, as the current exchange rate may change. To help smooth this volatility, gains and losses associated with this translation are reported on a reserve account, instead of the consolidated net income account, which is used in the temporal method.
This helps to reduce the volatility of consolidated earnings. It is also more helpful for management, shareholders, and creditors in evaluating a company because losses and gains resulting from currency translation are excluded from the accounting of consolidated earnings. In the current rate method, the cumulative translation adjustment (CTA), which is the loss/gain associated with the currency translation, is held on the balance sheet as an unrealized gain or loss.
Calculating With the Current Rate Method
When translating currency using the current rate method:
- The first step is to translate the income statement using the weighted average exchange rate observed over the reporting period.
- Next, assets and liabilities found on the balance sheet are translated at the current exchange rate. Note that issued capital stock is to be translated at the exchange rate observed on the date of issuance. Retained earnings are adjusted for net income less dividends.
- Finally, the balance sheet has to be re-balanced as a result of this accounting procedure. The CTA is used as a plug-in figure that nets out the asset side of the balance sheet with the liabilities and equity side. The CTA is treated as an unrealized gain or loss, which can subsequently be realized when the foreign subsidiary is sold or impaired.
Example of the Current Rate Method
An example would be a Canadian subsidiary of a U.S. company that does business using the Canadian dollar or "looney."
When converting foreign currencies to the company's presentation currency, the assets and liabilities listed on the balance sheet are converted to the presentation currency using the spot exchange rate as of the date on the balance sheet. Stock and retained earnings are translated at their historical rates, while income statement items are translated at the weighted average rate for the accounting period.