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Multinational companies conduct business activities where local reporting regulations may be different from those governing parent company financial statements. They operate in different economic conditions and in different currencies. Thus, these changes affect the reported operating performance
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Basically three problems arise for accounting of foreign transactions viz., choice of exchange rate, definition of exposure and disposition of translation adjustment. Choice of exchange rate depends upon the management intention. Definition of exposure and disposition of translation depends of the method used for translation.
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The choice of method depends of the choice of functional currency for each subsidiary company. Before the financial statements of a foreign branch, division, or subsidiary are translated into reporting currency, the management of the parent company must make a decision as to which currency is the functional currency of the foreign entity.
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Two methods are used for translation of foreign currency transactions viz., current rate method and temporal method. Under current method, the subsidiary is deemed to be independent of the parent's operations. All the income statement elements are translated at average rate. All the assets and liabilities are translated at the current rate except inventory. The translation gain or loss is included in the balance sheet as a part of equity.
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Under temporal method all the monetary assets are translated using the current rate and non-monetary assets are at historical rate. Revenues and expenses are translated at the average rate. Translation loss or gain is shown in the income statement.Translation gain or loss is calculated by adding holding affect and flow effect. The objective of analyzing foreign currency disclosures is to understand the firm economic exposure to exchange rates, the effects of rate changes on this exposure and whether the effects reported in financial statements reflect the economic effects appropriately or not. Treatment of effect of change in foreign exchange transactions is almost similar in all the countries.
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