Chartered Financial Analyst (CFA) Practice Exam Level 2

Which method requires creating the Income Statement first?

1. Temporal Method

2. All Current Method

3. Direct Quote Method

4. Indirect Quote Method

The correct answer is: All Current Method

The All Current Method is the correct choice because it involves translating all assets and liabilities at the current exchange rate while translating income statement items at the average exchange rate for the period. In this method, the income statement is constructed first before the balance sheet because it is essential to capture the financial performance for the period based on the average exchange rates. Once the income statement is translated, the balance sheet figures are then translated, allowing for a clear distinction between the transactional effects captured in the income statement and those reflected in the balance sheet using spot rates. This approach emphasizes reflecting the economic environment during which income and expenses were incurred, rather than the time when the transactions occurred. In contrast, the Temporal Method requires a different sequence and methodology for translation, focusing on maintaining the historical exchange rates for certain assets and liabilities. The Direct Quote Method and the Indirect Quote Method pertain more to how exchange rates are expressed rather than how financial statements are translated or organized.