Temporal method v.s. Current Rate Method

CFA Level II FRA
#1

Not sure if there is an answer to this question, but does anyone have any tips on remembering which fx rate to use for which Balance sheet / income statement items under Temporal method and Current Rate Method? Looks like there’re lots of expections and we’ll just memorise it (on top of other 1000 formula / rules to remember from the curriculum)…

Thanks!

#2

Current rate method

Net asset exposure

BS positions - Use current rate for all A/L positions except common stock (historical rate). Remember that BS positions are static (balances on certain date) so current rate is used.

P/L (IS) positions - Use average rate for all positions.

Remember that revenues/expenses are entries based on periodical (dynamic) basis thus average FX rate should be used, otherwise FX gain/losses will be over and underestimated by translation process.

Temporal method

Net monetary asset exposure

Monetary BS positions - Current rate

Non - monetary positions - historical rate (historical exch. rate means that no exposure to further FX movements)

P/L positions - use average rate only for those related to monetary BS positions, thus SG&A and revenues. For other items related to non monetary BS items use historical rate (COGS, depreciation).

Net income - Here we have additional category and this is mixed rate. It is backed up in fact that this position is based on both, P/L and BS items and monetary and non- monetary, so this is the reason why mixed rate approach is applicable.

Exhange rate gain/losses are booked in P/L under temporal method while are shown in equity (OCI) under current method so financial ratios are impacted by similar consequences as any other P/L vs OCI exposure.

Hope it helps.

#3

I decided to memorize a few pivotal points and then expand from that. So I memorized the current method well and derived the temporal method using differences from current method.

These two tables essentially summarize the reading. Any implications/ratio analyses can be logically derived on an on-demand basis. No need to prepare for such questions.

#4

The simple part

  • Monetary assets & liabilities: always at current rate
  • Common stock: always at historical rate
  • All revenue & most expenses: (almost) always at average rate

Temporal Moodiness

  • COGS and non-cash charges: at historical rate
  • Non-monetary assets & liabilities: current rate if measured at current value; otherwise, historical rate

Current-rate method: for when your kid moves abroad and starts dressing like locals.

Temporal method: for helicopter parents.

#5

Thanks everyone for the explainations (especially the funny metaphor from biuku:)). It definitely helps to memorize. Really appreciate it!