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Holt                                                                                                                                                                                               Advances in Business Research 

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The Fischer Black Method of Evaluating Accounting Alternatives Applied to Currency 

Translation Methods 
  

Paul Holt, Texas A&M University, Kingsville 
 

 

There is a massive foreign currency translation literature, but virtually no empirical research exists that tests 

alternative translation methods against normative criteria. This study compares three translation methods using the 

Black method of evaluating accounting alternatives. The translation method that performed best in this normative test 

was a price parity method, a method that has never been required or allowed under U.S. GAAP. 
 

 

 Black (1993) suggested that an important purpose of financial statements should be the maximization of the 

association between reported earnings and firm value. Reported earnings should be smoothed, through selection from 

among accounting alternatives, so that the time series of reported earnings would approach permanent earnings. As a 

result, reported earnings, scaled on price, would generate a single summary figure that would have the same 

implication for value across firms. Further, disclosures that could put a company at a competitive disadvantage would 

not be needed. 

 To determine which of two accounting methods is better, Black (1993) suggested the selection of the method that 

generates the more stable earnings/price ratio. He proposed a rank ordering of a sample of companies by 

earnings/price ratios. The first quartile average is divided by the third quarter average to give a measure of variation; 

the lower the variation, the greater the relationship between reported earnings and value. 

 The current study applies this methodology to the unresolved problem of which foreign currency translation 

method, the remeasurement method, the current rate method, or the price parity method, best associates reported 

earnings and value. 
 

Unsolved Problem 
 

Standard-setting bodies in the United States have required, at different times, four different translation methods. 

First, the current-noncurrent method was required; then the monetary-nonmonetary method in 1965; then a 

remeasurement method in 1975; and the current rate method in 1981. ASC 830 now requires either the remeasurement 

method or the current rate method, depending on circumstances, as described below.  

Many multinational companies, domiciled in various countries, use the remeasurement method for non-integrated 

subsidiaries and the current rate method for subsidiaries more closely integrated with the parent company (Holt, 2003). 

In the United States, ASC 830 requires either the current rate method or the remeasurement method. When the 

functional currency is the same as the currency of the subsidiary’s books and records, the current rate method is 

required. When the currency of the books and records of the subsidiary is not the same as the functional currency, the 

remeasurement method is required. 

The translation policy choices for Generally Accepted Accounting Principles (GAAP) in the U.S., as well as in 

other countries, have always been made with virtually no empirical knowledge of just what happens to consolidated 

financial statements when foreign accounts are translated by different methods. Houston (1986) observed that no 

translation method that has been used in the past has been demonstrated to be superior to other methods in any 

theoretical way. Clearly there is no closure on the foreign currency translation and consolidation problem in the United 

States, let alone worldwide. 
 

Obstacles to Empirical Research 
 

The lack of understanding of the effects of alternative translation methods on the relationship between reported 

earnings and value is not surprising. Companies use one translation method at a time, some feasible methods have 

never been used, and the effects of translation are buried in consolidated accounts. Unraveling these effects for a 

reasonable number of sample firms, for research purposes, would be a difficult project. Moreover, the temporally 

referenced item-by-item data required to construct comparable results under alternative translation methods are not 

available. 
 

Purpose of the Study 
 

There are a number of possible normative criteria against which to compare accounting alternatives, but this study 



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focuses on the relationship between reported earnings and price to determine which translation method gives the more 

stable relationship between price and earnings, in accordance with the Black model. The present study overcomes the 

obstacles to empirical research, described above, with a unique methodology.  

Previous studies have made various examinations of translation methods that, at different times, have been 

required by standard-setting bodies. They do not consider methods that have never been used, but which may be viable, 

even superior to other methods. Accordingly, the price parity method, a viable method which has never been required 

or allowed by standard setting bodies is included in the study. 
 

LITERATURE REVIEW 

 

The foreign currency translation literature is large and spans something like eight decades. Much of that literature 

is comprised of theories and opinions, and there are hardly any empirical studies that describe what actually happens 

when different translation methods are used, and there are virtually no empirical studies which test different 

translation methods against any normative criterion. 

A small number of studies are relevant to the notion of using the relationship between reported earnings and price 

to determine the superiority of one accounting method over another. Beaver and Dukes (1972) used this approach with 

a focus on the issue of interperiod tax allocation. May and Sundem (1973) applied similar tests of accounting policy 

decisions. Also relevant were Beaver and Dukes (1973) and Black (1993). 

During the past decade, a variety of foreign currency translation studies have appeared. Representative of these are 

the following: 
 

Pinto (2002) applied game theory to observe evidence of a degree of managerial opportunism in currency 

translation method preferences and suggested a lack of clarity in FASB’s classification scheme.  

Louis (2003) empirically examined the association between changes in firm value and foreign translation 

adjustments for manufacturing companies. The study found that the translation adjustment is associated with a loss of 

value instead of an increase in value, because for firms in the manufacturing sector, GAAP for foreign currency 

translation generally produces results opposite to the economic effects of exchange rate changes. 

Pinto (2005) tested the value relevance of foreign currency translation adjustments in an earnings and book value 

model and observed that foreign currency translation adjustments are significantly value relevant when their 

parameter estimates are allowed to vary in the cross-section. 

Iatridis et al (2006) found that early adopters of the U.K. Statement of Standard Accounting Practice No. 20 

“Foreign Currency Translation” were generally larger firms. Managements tended to adopt when the adverse 

economic consequences of adoption were likely to be minimal. They deferred adoption of the standard to influence 

their financial performance. The timing of the adoption is a matter related to the objectives of the managers in 

association with the market and economic conditions (Iatridis et al, 2005a). Income smoothing could be mitigated by 

appropriate standardization of accounting practice. 

Iatridis (2005b) empirically studied the U.K. stock market response to the implementation of the 1983 U.K. 

Statement of Standard Accounting Practice (SSAP) No. 20. The stock market appeared to have anticipated the 

implementation of SSAP 20. There was a positive stock market response in the official year of adoption, resulting 

from the income-stabilizing effects of the standard. The study also observed a significant relationship between stock 

returns and the accounting measures in the actual adoption period of the aggregate set of adopters. 

Kwon (2005) showed that foreign investors generally price exchange risk differently from local investors, and that 

the source and magnitude of differences in exchange risk pricing vary significantly across countries. 

Liu (2006) used an accounting-based equity valuation model for multinational firms to examine the forecasting 

and valuation properties of foreign currency translation gains and losses. The study found that translation gains and 

losses could be subdivided into a core component and a transitory component. The combined effect was that 

translation gains and losses were more transitory than transitory earnings. 

Chambers et al. (2007) provided evidence that other comprehensive income is priced by investors on a 

dollar-for-dollar basis. Two components of other comprehensive income, foreign currency translation adjustment and 

unrealized gains and losses on available-for-sale securities, were found to be priced by investors. But the study 

suggested that investors pay greater attention to other comprehensive information reported in the statement of changes 

in equity, rather than in a statement of financial performance. 

Holt (2006) empirically compared the variability of reported earnings resulting from eight foreign currency 

translation methods. The current rate method with non-deferral of translation gains and losses resulted in the highest 

average variability of earnings, and price parity methods resulted in lower variability than exchange rate methods as 

reflected by the average coefficients of variation of the study companies. However, results were highly firm specific. 



Holt                                                                                                                                                                                               Advances in Business Research 

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METHODOLOGY 
 

The purposes of this study were achieved by taking the following steps: 
 

Sixty U.S. companies were selected at random to build a data base of pre-translation financial statements. To be 

eligible for inclusion in the sample, a company must have had annual financial statements available for ten 

consecutive years ending in 2009. 

The financial statements of each of the sixty U.S. companies were translated from U.S. dollars to euros, using each 

of the three translation methods described below, for each of the five years 2005-2009, a total of 900 financial 

statement translations. Pre-translation accounting numbers were needed for ten years (2000-2009) in order to generate 

the temporal characteristics of certain accounts, such as fixed assets. 

For each of the three translation methods, the translated numbers were used to calculate the reported earnings to 

price ratio for each of the five years, for each of the sixty companies. The market value per share was the 

end-of-the-year price per common share, translated into euros at the spot exchange rate. 

In each of the three translation methods studied, there is a translation gain or loss in each accounting period. This 

gain or loss was included in the reported earnings number for study purposes. During the SFAS #8 and SFAS #52 era, 

the issue was whether these gains and losses should be included in reported earnings or deferred by bypassing the 

income statement and reporting them on a separate line on the balance sheet. In more recent years, the translation gains 

and losses are shown in other comprehensive income on the income statement, following the net income number. 

The present study does not attempt to resolve the issue of where these translation gains and losses should be shown 

on the financial statements. But it is reasonable to suppose that an efficient market would see through the location of 

these numbers, as long as the amounts of the gains and losses are disclosed. Including them in the reported earnings for 

study purposes provides appropriate numbers for comparing the three translation methods against the Black normative 

criterion. 

For each year, and for each of the three translation methods, the reported earnings to price ratios were rank ordered 

and arranged into quartiles (fifteen companies in each quartile). The average of the first quartile numbers was divided 

by the average of the third quartile number, in accordance with the Black methodology, for each of the three 

translation methods, for each of the five years in the study. 
 

Determination of Temporal Characteristics 
 

All foreign currency translation methods require that certain accounts be translated at the historical rate, the 

exchange rate that was in effect at the point in time an asset was acquired, a liability was incurred, a revenue or 

expense was recognized, or an element of owners’ equity was recorded. Such a point in time is referred to in the 

present study as a “temporal reference.” Since some account balances (such as fixed assets and long-term debt) are the 

result of numerous transactions over a considerable period of time, such account balances are made up of 

“components,” each consisting of a dollar (or other currency) amount and a temporal reference. The set of all such 

components is referred to in the present study as the “temporal characteristics” of a specific account balance. This set 

thus represents and describes a distribution of ages and related currency amounts of the account balance. 

Before translating these companies’ financial statements, it was necessary to determine these temporal 

characteristics of the pre-translation reported accounting numbers. Obtaining this information directly from the 

companies selected for the sample, for all the years studied, was impractical. This data problem has always been a 

major barrier to empirical research in foreign currency translation. This study overcame this barrier by estimating the 

temporal characteristics with a specially developed and tested estimation method. 

Three studies, relevant to the estimation of temporal characteristics, were Petersen (1971), Davidson et al. (1976), 

and Parker (1977). The purpose of these models was to generate estimated general price level data. Ketz (1977) 

provided detailed explanations of these three models, and Ketz (1978) tested their validity. He concluded that each of 

the three models is sufficiently accurate for research purposes. 

But the three models tested by Ketz are limited in that they estimate only the average ages of assets and liabilities. 

For the purposes of the present study, an estimation method that results in a distribution of ages for such accounts 

rather than merely an average age was desired. This estimation was most critical for fixed assets because of the relative 

size of fixed asset numbers. Fixed assets are translated at historical exchange rates under the remeasurement method, 

but at the current rate under the current rate method.  

A sophisticated method of estimation of temporal characteristics was developed for this study based on the 

assumption that asset retirements occur in FIFO fashion and using published purchase and retirement data. Details of 

this estimation method are available in Holt (2012). The method was tested against 1,200 theoretical companies with 

the following results: 18 percent of the estimates resulted in a translation error of less than 1 percent, 79 percent in 



Holt                                                                                                                                                                                               Advances in Business Research 

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errors of less than 5 percent, 99 percent in errors of less than 10 percent, and none of the estimates resulted in 

translation errors of more than 11.37 percent (Holt, 2012). 
 

Translation Methods 
 

This study examined two methods which encompass the history of GAAP in the United States as well as a price 

parity method. These three methods were as follows: the remeasurement method of ASC 830, the current rate method 

of ASC 830, and the price parity method. 

The translations were made from U.S. dollars to euros to generate the post-translation numbers needed to calculate 

earnings per share under each of the three methods studied. 

These three translation methods were selected for the present study because they are viable methods, not 

specifically because two of them are required, under different circumstances, by U.S. GAAP. Many other, 

mechanically possible, methods could have been tested, but such methods (such as a current / noncurrent rate method) 

do not have a theoretical base. 
 

 Remeasurement Method (RM): The remeasurement method is required by ASC 830 when the currency of the 

books and records of a foreign subsidiary is different from the functional currency. Monetary assets and liabilities are 

translated at the current exchange rate, whereas nonmonetary assets and liabilities and stockholders’ equity are 

translated at the historical exchange rate. Income statement items that are related to nonmonetary assets and liabilities 

are translated at the same rate used for the related balance sheet translation. Other revenue and expense accounts which 

occur evenly over the year may be translated at the weighted-average exchange rate. The objective of the method is to 

preserve the underlying accounting principles of historical cost so that consolidation is possible on a consistent basis 

(Demirag, 1987). 
 

 Current Rate Method (CR): The current rate method is required by ASC 830 when the subsidiary’s functional 

currency is different from the reporting currency of the consolidated entity. In this method, all balance sheet items, 

with the exception of owners’ equity, are translated at the current exchange rate. Owners’ equity is translated at 

historical rates. Income statement items are translated at the exchange rate that was in effect when the transactions 

occurred, although those that occur evenly over the year may be translated at the average exchange rate. 
 

 Price Parity Method (PP): Each of the exchange-rate-based translation methods has its supporters and detractors, 

and none has been shown theoretically or empirically to be superior to the others under all circumstances. Patz (1978) 

suggests this long-standing dilemma may result from the use of exchange rates themselves. There is no rigorous 

defense in existence for the use of exchange rates, and exchange rates are not related in any clear way to accounting 

measures. Indeed, in 1974, the Committee on International Accounting called for an investigation of the purchasing 

power parity (PPP) theory approach as a possible alternative to exchange rate methods. Such a PPP-based theory of 

translation is developed in Patz (1977) and the resulting Price Parity Method is described in full in Patz (1981). 
 

 Briefly, the PPP theory of foreign currency translation assumes that the property to be measured is local command 

over goods and services as expressed by currency unit accounting measures. Under the PPP system, foreign accounts 

are restated in the reporting currency, but using price parity relative purchasing power indices instead of exchange 

rates, under a temporal method approach, in an attempt to express command over goods and services with respect to 

the economy in which the entity functions. It is assumed that foreign subsidiaries do not exist solely for the purpose of 

generating cash flows to the parent, but rather for the maximization of economic power which can be defined as the 

size of assets held. The purpose of the existence of foreign subsidiaries is to maximize this command over goods and 

services in the foreign environment. 

 The present study applies the price parity theory of exchange rates as summarized in Officer (1982) in three 

propositions: (1) PPP is the principal determinant of the long-run equilibrium exchange rate, (2) the short-run 

equilibrium exchange rate in any current period is a function of the long-run equilibrium exchange rate in the sense 

that the latter variable is the principal determinate of, and tends to be approached by, the former, (3) the short-run 

equilibrium exchange rate in any current period is determined principally by PPP, with the former variable tending to 

equal the latter. 
 

Parent Companies’ Domiciles 
 

 Obtaining a meaningfully large sample of the financial statements of foreign subsidiaries prior to their translation 

and consolidation with the accounts of their parent companies is not practical. In this study, U.S. companies were used 



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as hypothetical subsidiaries of a parent company in a country that uses the euro, under the notion that there is no reason 

to conclude that they could not become so. Parent companies are not identified. The focus is on the subsidiary 

accounting numbers, resulting from three translation methods, prior to consolidation. But translation from dollars to 

euros would be necessary if the consolidated entity’s reporting currency was the euro. Thus, the theoretical parent 

company could be domiciled in any of several countries which use the euro. 

 Several advantages attach to this approach beyond generating a sample sufficiently large to support generalization. 

The effects of transactions between parent and subsidiary which must be eliminated in translation and consolidation 

are not present. Also, any effects the actual use of a specific translation method might have in real parent/foreign 

subsidiary settings on management financing and operating decisions are avoided. 

 Some of the U.S. companies selected as hypothetical subsidiaries may themselves have foreign subsidiaries. Thus 

the accounts of these U.S. companies may already be affected by the currency translation of their own foreign 

subsidiaries. This factor is not considered a problem in the present study, inasmuch as in practice it is not at all unusual 

for a subsidiary to also be a parent. 

 The current rate method and the remeasurement method use exchange rates for translation. However, the price 

parity method uses relative price level data which varies from country to country, despite a common reporting 

currency (the euro). Accordingly, this study posits ten parent companies in each of six countries, Finland, France, 

Germany, Italy, the Netherlands, and Spain, which results in the application six different time series of price parity 

numbers. These particular six countries were selected at random from the population of countries which use the euro, 

and are presumed to provide a fair representation. 
 

Results and Conclusions 
 

Dividing the average of the first quartile’s earnings/price ratios by the third quartile’s earnings/price ratios, 

resulted in the following table, where CR is the current rate method, RM is the remeasurement method, and PP is the 

price parity method: 
 

Table 1: Division of the Average of the First Quartile Earnings/price  

Ratio by the Average of the Third Quartile earnings/price Ratio 
 

Year CR RM PP 

2005 H 2.203 2.196 L 1.928 

2006 L 2.066 H 3.267 2.124 

2007 2.120 H 2.208 L 1.818 

2008 L 2.080 H 2.213 2.202 

2009 2.119 H 2.169 L 2.110 

Average 2.118 H 2.411 L 2.096 

 

H indicates the method with the highest first to third quartile ratio for the year. L indicates the method with the 

lowest first to third quartile ratio for the year. 

 Relevant to the analysis is the fact that the time series of price parity numbers, dollars to euros, is significantly less 

variable than the exchange rate from dollars to euros, as indicated by the following table: 
 

Table 2: Variances of Time Series Exchange Rates from US Dollars to Euros and Time Series of Price  

Parity Numbers of Six Selected Countries (Monthly Observations, January, 2001 - October, 2009) 
 

 Exchange Rate PP Finland PP France PP Germany PP Italy PP Netherlands PP Spain 

Variance .0221 .0009 .0010 .0021 .0029 .0028 .0069 

Rank by Variance 1 7 6 5 3 4 2 

 

The variance of the time series of exchanges rates, dollars to euros, is clearly greater than the variance of the time 

series of price parity numbers of each of these six selected countries. This pre-study observation led the author to 

anticipate that the present study would show that the price parity method of translation would clearly be preferable, 

based on the Black normative criterion. This anticipated result was partially confirmed by the actual study results 

(Table 1), as PP appears to be the best translation method choice for three of the five study years (three years in which 

the use of PP resulted in the lowest first to third quartile ratio). 

 The remeasurement method, the translation method required in the U.S. by ASC 830, and in a number of other 

countries, when the currency of the foreign subsidiary’s books and records differs from the functional currency, 

performed poorly compared to the current rate method and the price parity method. Its use resulted in the highest (least 

desirable) first to third quartile ratios in four of the five study years. 



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Limitations and Suggestions for Future Research 
 

This study compared three translation methods, two of which are required in the U.S. by ASC 830, under differing 

circumstances, and one viable method, which has never been required or allowed, against only one normative criterion. 

Future studies should identify additional normative criteria and test translation methods against those criteria. Upon 

the completion of several such empirical, normative studies, it may eventually be possible to observe if one translation 

method consistently out-performs other methods, or if different translation methods are superior for different 

normative criteria. Further, because of the performance of the price parity method in the present study, price parity 

methods should be included in future empirical, normative studies. 
 

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Beaver, W., & Dukes, R. 1972. Interperiod tax allocations, earnings expectations, and the behavior of security prices. 

Accounting Review, 47(April), 320-332. 
 

Beaver, W., & Dukes, R. 1973. Interperiod tax allocation and depreciation methods: Some empirical results. 

Accounting Review, 48(July), 549-559. 
 

Black, F. 1993. Choosing accounting rules. Accounting Horizons, December, 1-17. 
 

Chambers, D., Linsmeier, T., Shakespeare, C., & Sougiannis, T. 2007. An evaluation of SFAS No. 130 comprehensive 

income disclosures. Review of Accounting Studies, 12(4), 557-593. 
 

Davidson, S., Stickney, C., & Weil, R. 1976. Inflation accounting. A guide for the accountant and the financial 

analyst. New York: McGraw-Hall. 
 

Demirag, I. 1987. A review of the objectives of foreign currency translation. International Journal of Accounting 

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Financial Accounting Standards Board. 1975. Accounting for the translation of foreign currency transactions and 

foreign currency financial statements. Statement of Financial Accounting Standards No. 8. Stamford, 

Connecticut: FASB. 
 

Financial Accounting Standards Board. 1981. Foreign currency translation. Statement of Financial Accounting 

Standards No. 52. Stamford, Connecticut: FASB. 
 

Holt, P. 2003. International accounting. Cincinnati, Ohio: Thomson Learning. 
 

Holt, P. 2006. The variability of earnings across foreign currency translation methodologies: An empirical comparison. 

Southwest Business and Economics Journal, 67-81. 
 

Holt, E. 2012. Estimation of temporal characteristics of accounts for empirical research. Advances in Business 

Research, 2(1), 231-237. 
 

Houston, C. 1986. “U.S. Management Hedging Practices Subsequent to the Adoption of SFAS No. 52 ‘foreign 

currency translation’.” Unpublished Ph.D. dissertation. University of Washington. 
 

Iatridis, G., & Joseph, N. 2005a. A conceptual framework of accounting policy choice under SSAP 20. Managerial 

Auditing Journal, 20(7), 763-778.  
 

Iatridis, G. 2005b. An empirical investigation of the U.K. stock market response to the implementation of SSAP 20 

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Ketz, J. 1977. “A comparison of the predictability of business failure by the financial ratios of general price 

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Polytechnic Institute and State University. 
 



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Ketz, J. 1978. The validation of some general price level estimating models. Accounting Review, LIII(4), 952-960. 
 

Taek H., Bae, S., & Chung, J. 2005. Do foreign investors price foreign exchange risk differently? Journal of 

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May, R. & Sundem, G. 1973. Cost of information and security prices: Market association tests for accounting policy 

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Officer, L. 1982. Purchasing power parity and exchange rates: Theory, evidence and relevance. Greenwich, 

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Parker, J. 1977. Impact of price-level accounting. Accounting Review, 52(1), 69-96. 
 

Patz, D. 1977. The state of the art in translation theory. Journal of Business Finance and Accounting, 4(3), 311-325. 
 

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adjustments. Journal of International Financial Management & Accounting, 16(2), 97-122. 
  

 

Paul Holt is a professor of accounting at Texas A&M University, Kingsville. He received his Ph.D. in international 

accounting from Oklahoma State University. His current research focuses on descriptive and normative studies of 

foreign currency translation methodologies. He has published in Advances in Business Research, American Journal of 

Economics and Business Administration, Journal of Theoretical Accounting Research, Southwest Business and 

Economics Journal, Accounting Forum, and Journal of Accounting and Finance Research. 


