Translating a Foreign Subsidiary Income Statement Using the All-Current Method
When foreign operations are translated using the all-current method, all income statement items are translated at the ending exchange rate. Since a single exchange rate is being used, all income statement ratios (such as profit margins) will be the same when translated as they were in the subsidiary’s currency. Retained earnings, however, may be affected by any dividends, which are translated at the rate in effect at the time the dividend was paid.
The parent company will show higher revenue and profits when the foreign currency strengthens, and lower revenue and profit when the foreign currency weakens. If the foreign subsidiary’s margins differ significantly from the parent company’s overall profitability, changes in the foreign currency will impact the profit margins reported by the parent since the translated percentage of sales and profits will differ.
Consider a US company with a Japanese subsidiary. The chart below translates the Japanese unit’s results into the parent company income statement under the assumption of stable, rising and falling currencies.
Now consider the impact on the parent’s consolidated income statement. In the example below, the non-Japanese operations of the U.S. company are summarized in the left column, and the other columns add in the Japanese results. The U.S. operations are less profitable than those in Japan, and the fluctuations in the yen impact not just the total dollar revenue and sales but the consolidated profit margins as well.
Investors noticing a rising or falling profit margin would want to understand whether it was stemming merely from changes in currency or whether it was an underlying business trend.
For more information, see all articles on: Accounting, Adjusting Reported Financial Statements See also:
The Intelligent Investor: The Classic Text on Value Investing
Financial Statement Analysis: A Practitioner's Guide, 3rd Edition
Managing Investment Portfolios: A Dynamic Process (CFA Institute Investment Series)
