Video: Translation Method of Converting Financial Statements

In this lesson, Nick Palazzolo, CPA, breaks down the translation method used in converting financial statements when dealing with foreign subsidiaries and different currencies. He begins by clarifying under what circumstances the translation method is employed, specifically when the functional currency differs from the reporting currency. Nick then walks through the step-by-step process, starting from the income statement and cogently explaining why this step precedes the balance sheet adjustments. With a focus on how income statement items like revenues and expenses lead to net income and eventually roll into retained earnings, he also covers the application of various exchange rates such as weighted average, historical, and current year-end rates. Moreover, Nick talks about where translation adjustments should be reflected, using the puffer mnemonic as a memorization aid, and why these are recognized in Other Comprehensive Income (OCI), offering insights into the nuances of foreign currency translation that go beyond mere operational performance.

"Examprep.ai helped me pass all 4 CPA exams on the first try. I highly recommend. I especially like the feedback and ratings the software provides so I know where to focus my time."

Daniel H., CPA

"I can't recommend ExamPrep.ai enough. Nick's lessons turned concepts I struggled with into strengths. I was able to pass FAR right before other exams expired!"

Andrew K, CPA

"I just want to say thank you for the great lesson videos. I couldn't stay awake through lectures of another course. After watching all your FAR lessons I was finally able to pass!"

Alyssa M., CPA Candidate

Video Transcript

Instructor: Nick Palazzolo

Nick Palazzolo is head instructor of ExamPrep.ai CPA Review. Nick's teaching style is engaging & upbeat, combining practical Big 4 tax & assurance expertise with years of 1-on-1 coaching. His lessons are concise and emphasize what you need to know to pass. Whether you're a recent grad or working full-time, we’re confident you can conquer your CPA exams with Nick’s review.

Cite this lesson

Link to this page

[[ citeExample ]]

Copy to clipboard

Copy URL to clipboard

Copy HTML to clipboard

All right, well, here we have the translation method and then we'll go through the remeasurement method. Okay, so when do we use the translation process? We are just seeing example after example, right? So when the functional currency is not the same as the reporting currency and this is done at year end. Okay.

If a foreign subsidiary's financial statements are in the subsidiary's functional currency, which needs to be converted to the parent's currency as per GAAP, the foreign financial statements are translated to the reporting currency starting with the income statement. We always start with the income statement. And why is that? Because your revenues minus expenses equals net income. Net income becomes retained earnings.

Retained earnings goes on the balance sheet. That's why you always start with the income statement, even in just the financial statement preparation process. Well, our first conversion, we convert the income statement. We use the weighted average rate for all of these. This is the whole process of translation.

We are taking the income statement items. We transfer net income to retained earnings, everything's in this currency. Now, we use the historical rate for our equity amounts, right? And we roll forward the retained earnings onto the balance sheet. We use our current year-end rate for the assets, whatever that date is. Generally, it's going to be the year-end unless we do mid-year or something. Same with Liabilities. However, like I did say, we are going to use the historical rate for inventory or anything else that is valued at historical rate. Translated retained earnings. So beginning translated retained earnings plus translated net income for the current period, less translated dividends declared for the current period.

This is the whole process hopefully starting to really drill down and become more clear in your mind what

Unlock the full video transcript and subtitles support with a free account!

Get more from this lesson

Create an account Get started free. No credit card required.

Specialized Financial Reporting Topics

Module: 5 Concepts, 42 Videos

Derivatives and Hedge Accounting Overview

0:40

Derivatives and Hedge Accounting Objectives

1:03

Terminology for Derivatives and Hedge Accounting

6:24

Forwards and Futures