Current Rate Method
The current rate method is the simplest: All balance sheet and income items are translated at the current rate. This method is widely employed by British companies. With some variation, it is the method mandated by the current U.S. translation standard—FASB 52. Under the current rate method, if a firm’s foreign-currency-denominated assets exceed its foreign-currency-denominated liabilities, a devaluation must result in a loss and a revaluation must result in a gain.
Exhibit 10.2 applies the four methods to a hypothetical balance sheet that is affected by both a 25% devaluation and a 37.5% revaluation. Depending on the method chosen, the translation results for the LC devaluation can range from a loss of $205,000 to a gain of $215,000; LC revaluation results can vary from a gain of $615,000 to a loss of $645,000. The assets and liabilities that are considered exposed under each method are the ones that change in dollar value. Note that the translation gains or losses for each method show up as the change in the equity account. For example, the LC devaluation combined with the current rate method results in a $205,000 reduction in the equity account ($1,025,000 − $820,000), which equals the translation loss for this method. Another way to calculate this loss is to take the net LC translation exposure, which equals exposed assets minus exposed liabilities (for the current rate method, this figure is LC 4,100,000, which, not coincidentally, equals its equity value) and multiply it by the $0.05 ($0.25 − $0.20) change in the exchange rate. This calculation yields a translation loss of $205,000 ($0.05 × 4,100,000), the same as calculated in Exhibit 10.2. Another way to calculate this loss is to multiply the net dollar translation exposure by the fractional change in the exchange rate, or $1,025,000 × 0.05/0.25 = $205,000. Either approach gives the correct answer.