Using Translated Foreign-Currency Financial Statements  521
Using Translated Foreign-Currency Financial Statements
To conduct analysis of the historical performance of foreign businesses, it’s 
best to use the foreign currency. But this is impossible if you are conducting 
your analysis on an outside-in basis and the business’s statements in foreign 
currency have been translated into its parent company’s domestic currency 
and consolidated in the parent’s accounts.
For example, a British subsidiary of a European corporate group will al-
ways prepare financial statements in British pounds, and when the European 
parent company prepares its financial statements, it will translate the British 
pounds in the statements of the British subsidiary at the current euro–pound 
exchange rate. However, if the exchange rate fluctuates from year to year, 
the European parent company will report the same asset at a different euro 
amount each year, even if the asset’s value in British pounds has not changed. 
This change in the value of the British asset in the parent’s reporting currency 
would suggest a cash expenditure. But no cash has been spent, because the 
change is solely due to a change in the exchange rate. Therefore, following the 
guidelines from Chapter 11, you need to make a correction to the cash flow 
estimated from the financial statements that is equal to the gains or losses 
from the currency translation.
Three Approaches
Between them, U.S. GAAP and IFRS sanction three approaches to translating 
the financial statements of foreign subsidiaries into the parent company’s cur-
rency: the current method, the temporal method, and the inflation-adjusted 
current method. Exhibit 27.5 shows the approach recommended by each stan-
dard for countries with moderate inflation and for those with hyperinflation.
EXHIBIT 27.5  Currency Translation Approaches
Current method
Current method
Temporal method
Moderate inflation
Hyperinflation
Inflation-adjusted
current method
U.S. GAAP
IFRS

522  Cross-Border Valuation
Current Method  For subsidiaries in moderate-inflation countries, translating 
the financial statements into the currency of the parent company is straight-
forward. Both U.S. GAAP and IFRS apply the current method, which requires 
translating all balance sheet items except equity at the year-end exchange rate. 
Translation gains and losses on the balance sheet are recognized in the equity ac-
count in other comprehensive income (OCI), so they do not affect net income. The 
average exchange rate for the period is used to translate the income statement.
For subsidiaries in countries with higher inflation rates, IFRS and U.S. GAAP 
differ in what they define as hyperinflation, whether to adjust statements for 
inflation, and what approach to use for translating the financial statements. 
U.S. GAAP defines hyperinflation as cumulative inflation over three years of 
approximately 100 percent or more. IFRS states that this is one indicator of hy-
perinflation but suggests considering other factors as well, such as the degree 
to which local investors prefer to keep wealth in nonmonetary assets or stable 
foreign currencies.
Temporal Method  U.S. GAAP requires companies to use the temporal 
method for translating financial statements of subsidiaries in hyperinflation 
countries into the parent’s currency. To use this method, you must translate 
all items in the financial statements at the exchange rate prevailing at the rel-
evant transaction date. This means using historical exchange rates for items 
carried at historical cost, current exchange rates for monetary items, and year-
average or other appropriate exchange rates for other balance sheet items and 
the income statement. Any resulting currency gains or losses are reported in 
the equity account of the parent in OCI.
Inflation-Adjusted Current Method  The IFRS approach to currency trans-
lation for subsidiaries in hyperinflation countries is like that for moderate-
inflation countries. The key difference? IFRS requires that the hyperinflation 
country statements be restated in current (foreign) currency units based on a 
general price index before they are translated into the parent company’s cur-
rency. All except some monetary items need to be restated to account for the 
estimated impact of very high inflation on values over time. The restatement 
will result in a gain or loss on the subsidiary’s income statement. Because the 
full statements are restated in current (year-end) foreign-currency units, the 
year-end exchange rate should be used to translate both the balance sheet 
and the income statement into the parent company’s currency. Any translation 
gains or losses will be included in the equity account of the parent in OCI.
An Application of the Methods
Exhibit 27.6 shows an example for a U.S. parent company using all three 
approaches to currency translation. In this example, the exchange rate has 
changed from 0.95 at the beginning of the year to 0.85 at the end of the year,