Translation Methods and Financial Statement Effects
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Temporal Method & Financial Statement Effects
- Income Statement Volatility: Under the temporal method, translation gains or losses are reported directly on the income statement. Therefore exchange rate volatility can create net income volatility for companies consolidating subsidiaries with the temporal method.
- Balance Sheet Exposure: Monetary assets and liabilities are exposed to translation at current exchange rates. If exposed assets exceed exposed liabilities, then the foreign subsidiary has a net balance sheet exposure. Therefore, a translation loss will occur when the foreign currency weakens. If exposed liabilities exceed exposed assets, then a translation loss will occur when the foreign currency strengthens. It is important to be mindful of the subsidiary's balance sheet exposure and the movement of its local currency when analyzing a company that consolidates with the temporal method.
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