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Different foreign currency translations

1. Does the choice of different foreign currency translation methods affect the comparability of the financial statements of two otherwise similar companies?

2. Is it likely to be significant enough to influence a potential investor?

This is an example:

Does the choice of different foreign currency translation methods affect the comparability of the financial statements of two otherwise similar companies?

Yes, the choice of different foreign currency translation methods can affect the comparability of the financial statements of two otherwise similar companies. When comparing the current rate method and temporal method a few differences can be seen with a single assumption. If we assume the local currency is appreciating compared to the USD, you can expect the current rate method could report a lower gross profit margin. Also, since depreciation under the current rate method is the average exchange rate, it can report higher operating expenses when compared to the temporal method. An appreciating local currency could also result in differences between a few key financial ratios. Under the current rate method, the fixed asset turnover, return on assets, and return on equity ratios can all be lower. These changes are all under a single assumption. When comparing the financials under stable currency exchange rates the differences will be small.

Is it likely to be significant enough to influence a potential investor?

The significance to potential investors all depends on the stability of the local currency exchange rate with the USD. If the rate is stable, the two companies will have similar trending financials. However, when the local currency is appreciating or depreciating to the USD differences will show. The degree of the effect on the financials all depends on the severity of the currency exchange rate fluctuations. Without the knowledge of the reporting method, the trends of the financial ratios can sway potential investors even though both are otherwise similar companies.

Resource:

Saudagaran, S., & Smith, L. (2013). International accounting: A user perspective (4th ed.).

Solution Preview

The response addresses the queries posted in 525 words with references.
// Foreign currency translation methods play important role in the comparability of the financial statements of two otherwise similar companies. Here, we will discuss the effects of different foreign currency translation methods.//

Answer 1

The different foreign currency translation methods affect the comparability of the financial statements of two otherwise similar companies due to the change in the basis of translation of balance sheet items and income statement items (Saudagaran & Smith, 2013). In case of current rate method, all the assets and liabilities are translated at the current exchange rate on balance sheet date. However, in case of temporary rate method, some assets and liabilities are translated at the exchange rate on balance sheet data, while some of assets and liabilities are translated at the historical exchange rate. For instance, accounts receivables and ...

Solution Summary

This solution discusses foreign currency translations.

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