Answers - Reading 10 Multinational Operations

Wasson Brothers (WB) is a large U.S. based conglomerate with many subsidiaries in both the U.S. and abroad. One of WB's wholly-owned foreign subsidiaries, Kasamatsu Industries, is based in Japan and manufactures a hugely successful line of trading cards, toys, and other related products. All of Kasamatsu's operations and sales take place in Japan, and the corresponding transactions are denominated in Japanese yen. Additionally, Kasamatsu's books and records are all maintained in yen. WB reports its earnings in U.S. dollars. The history of the exchange rate between the dollar and the yen over the last two years is presented in the following table. Figures are presented in Yen/dollars. Yen/Dollar Exchange Rate December 31, 2005 150 December 31, 2004 130 2005 Average 140 2004 Average 120 Exchange rate on date that 2005 dividends were declared by Kasmatsu Exchange rate on date of stock issue and acquisition of fixed assets. 145 100 Ashley Jameson is an analyst with Henderson-Wells, an investment banking firm in New York, and is the chief analyst covering WB. She believes that the enormous success of the trading cards has contributed greatly to WB's bottom line. However, she believes that this effect may be misstated in the company's financial statements because of the recent volatility in exchange rates. Many analysts at other major investment banking firms have been raising their ratings on WB because of the recent earnings growth. Jameson, however, wants to be absolutely certain that these results are accurate and fully attributable to Kasamatsu's hot new product and not a result of an exchange rate fluctuation. The following are the financial statements of Kasamatsu, stated in thousands of yen. Financial Statements for Year Ending December 31, 2005 (in thousands of yen) Statement of Income and Retained Earnings Sales 700,000 Expenses Cost of Goods Sold (COGS) 280,000 Depreciation 126,000 SG&A 77,000 Total Expenses Earnings Before Taxes (EBT) 483,000 217,000 Income Tax Expense 98,000 Net Income 119,000 Retained Earnings: December 31, 2004 250,000 369,000 Dividends 58,000 Retained Earnings: December 31, 2005* 311,000 * Retained earnings on 12/31/2005 were US $2million Balance Sheet Assets Cash and receivables 60,000 Inventory 180,000 Land 200,000 Fixed assets 346,000 Total assets 786,000 Liabilities and stockholders' equity Liabilities 300,000 Capital stock 175,000 Retained earnings 311,000 Total liabilities and stockholders' equity 786,000 Question #1 - 2 of 82 Question ID: 1472535 Before Jameson can perform any financial statement analysis she needs to determine which method WB uses to translate Kasamatsu's earnings into U.S. dollars (USD). Which of the following is the most appropriate method to use? A) First the temporal method, followed by the current rate method. B) The current rate method. C) The temporal method. Explanation The basis for using the current rate method is when Functional Currency is NOT the same as Parent's Presentation (reporting) Currency. The basis for using the temporal method is when Functional Currency = Parent's Presentation Currency. Under US GAAP the current method must be used to translate the yen financial statements into USD, the reporting currency. Had Kasamatsu been operating in a highly inflationary environment or had the local and functional currency not been the same, then WB would be required to use the temporal method. (Module 10.4, LOS 10.e) Question #2 - 2 of 82 Question ID: 1472536 Jameson must also determine how the fluctuation in the yen vs. the dollar has affected Kasamatsu's earnings in the reporting currency. Which of the following best describes the effect of changes in the yen/dollar rate has had on earnings in the reporting currency? Earnings have: A) decreased because the yen is depreciating versus the USD. B) increased because the yen is depreciating versus the USD. C) increased because the yen is appreciating versus the USD. Explanation Examination of the history of the exchange rate shows that both the year-end and average exchange rates are lower in 2005 than in 2004 (lower in that the yen has weakened vs. the USD). Therefore, Kasamatsu has to earn more yen than it did in the previous year for WB to be able to report the same dollar amount of net income. This means that the true economic performance of Kasamatsu is understated when viewed as a component of WB's net income. (Module 10.4, LOS 10.e) Question #3 of 82 Question ID: 1472532 Which of the following statements regarding foreign currency translation are least accurate? Under the: A) temporal method, sales are remeasured using the average rate. B) C) current rate method, the foreign currency translation gain or loss appears on the parent firm's income statement. temporal method, COGS and depreciation are remeasured using the historical rate. Explanation Under the current rate method, the foreign currency translation gain or loss appears on the parent firm's balance sheet in the equity accounts. (Module 10.4, LOS 10.e) Question #4 of 82 Question ID: 1472538 Global International Corp. (GIC) has three subsidiaries: GIC Europe whose local currency is the euro and whose functional currency is the euro; GIC China whose local currency is the yuan and whose functional currency is the Hong Kong dollar; and GIC Bahamas whose local currency is the Bahamian dollar and whose functional currency is the U.S. dollar. GIC's reporting currency is the U.S. dollar. Which conversion methods should be used by GIC for each of its subsidiaries? GIC Europe’s data should be remeasured under the temporal method; GIC China’s data should be remeasured under the temporal method into Hong Kong A) dollars, and then translated under the current rate method into U.S. dollars; and GIC Bahamas’ data should be translated under the current rate method into U.S. dollars. GIC Europe’s data should be translated under the current rate method; GIC China’s data should be remeasured under the temporal method into Hong Kong B) dollars, and then translated under the current rate method into U.S. dollars; and GIC Bahamas’ data should be remeasured under the temporal method into U.S. dollars. C) The financial data for all three subsidiaries should be remeasured under the temporal method. Explanation The basis for using the current rate method is when Functional Currency is NOT the same as Parent's Presentation (reporting) Currency. The basis for using the temporal method is when Functional Currency = Parent's Presentation Currency. GIC Europe's data should be translated under the current rate method; GIC China's data should be remeasured under the temporal method into Hong Kong dollars, and then translated under the current rate method into U.S. dollars; and GIC Bahamas' data should be remeasured under the temporal method into U.S. dollars. (Module 10.4, LOS 10.e) Question #5 of 82 Question ID: 1472510 Which of the following general statements is CORRECT with respect to the temporal method? Monetary assets are: A) translated at the current rate. B) translated at the average rate. C) not translated. Explanation As a general rule in using the temporal method, monetary assets are translated using the current rate. (Module 10.3, LOS 10.e) Question #6 of 82 Question ID: 1472529 Which of the following statements is NOT a characteristic of the current rate method of accounting for foreign currency translation? A) All asset accounts are translated at the current rate of exchange as of the balance sheet date. B) Nonmonetary liabilities are translated at the historical rate of exchange. C) The common stock account is translated at the rate of exchange that applied when the equity was issued. Explanation Under the current rate method, all liabilities are translated at the current rate of exchange. (Module 10.4, LOS 10.e) Question #7 of 82 Question ID: 1472560 The Herlitzka Company, a U.S. multinational firm, has a 100% stake in a Swiss subsidiary. The Swiss franc (SF) has been determined to be the functional currency. All the common stock of the subsidiary was issued at the beginning of the year and the subsidiary uses the FIFO inventory cost-flow assumption. In addition, the value of the SF is as follows: Beginning of year $0.5902 Average throughout the year $0.6002 End of year $0.6150 The SF-based balance sheet and income statement data for the Swiss subsidiary are as follows: Accounts receivable = 3,000 Inventory = 4,000 Fixed assets = 12,000 Accounts payable = 2,000 Long-term debt = 5,000 Common stock = 10,000 Retained earnings = 2,000 Net income = 2,000 The translated value of common stock and long-term debt respectively are: A) $6,150 and $3,075. B) $5,902 and $3,075. C) $5,902 and $3,001. Explanation The basis for using the current rate method is when Functional Currency is NOT the same as Parent's Presentation (reporting) Currency. The basis for using the temporal method is when Functional Currency = Parent's Presentation Currency. Since the SF is the functional currency, use the current rate method. Common stock is translated at the historical rate which is the rate that applied when the transaction was made or $0.5902 and long-term debt is translated at the current rate of $0.615. 10,000 × 0.5902 = $5,902 for common stock and 5000 × 0.6150 = $3,075 for long term debt. (Module 10.6, LOS 10.f) Question #8 of 82 Question ID: 1472487 The local currency is: A) the preferred functional currency for subsidiaries that are highly integrated with the parent. B) translated into the functional currency under the current rate method. C) the same as the functional currency under the current rate method. Explanation The local currency is best described as the currency of the country in which the foreign subsidiary is located. If a subsidiary is highly integrated with its parent or operating in a high-inflation environment, the functional currency is the parent's currency. Local currencies are remeasured under the temporal method. (Module 10.1, LOS 10.a) Question #9 of 82 Question ID: 1472556 Which of the following statements is most accurate concerning foreign currency translation? In the case in which a firm uses first in, first out (FIFO) inventory valuation, if the A) local currency depreciates the cost of good sold under the temporal method is less than the cost of goods sold using the current rate method. B) C) In the case of an appreciating currency, the fixed asset turnover will be lower under the temporal method, as compared to the current rate method. The receivables turnover ratio is identical under both the temporal method and the current rate method. Explanation The receivables turnover (sales / receivables) is unaffected because both methods translate sales at the average rate and accounts receivable at the current rate. When using FIFO and the temporal method we assume that the appropriate rates to use for cost of goods sold (COGS) are the older historical rates. The average rate is used for COGS under the current rate method. If the local currency depreciates, COGS would be higher under the temporal method. With an appreciating currency the fixed asset turnover ratio (sales / fixed assets) will be higher using the temporal method because the temporal method uses the historical rate for fixed assets whereas the current rate method uses the current rate. They both use the same average rate for sales. (Module 10.6, LOS 10.f) Question #10 of 82 Question ID: 1472504 Under the temporal method, the inventory and cost of goods sold (COGS) accounts are both nonmonetary accounts. Which of the following statements is least accurate regarding these accounts? A) B) C) If the firm accounts for inventory using last in, first out (LIFO), then the beginning-of-period rate is used to remeasure COGS. The Inventory account is remeasured using the historical rate under both LIFO and FIFO. If the firm accounts for inventory using first in, first out (FIFO), then a more recent rate will be applied to the inventory account. Explanation Under LIFO, the last goods purchased are the first goods out to COGS. Hence, although technically the historical rate is used to remeasure COGS, a more recent rate is typically more appropriate for COGS under LIFO. (Module 10.3, LOS 10.e) Question #11 of 82 Question ID: 1472528 Which of the following statements is least accurate regarding accounting for foreign currency translations? The: A) current rate method applies the average exchange rate to all income statement accounts. B) C) temporal method uses the historical exchange rate to translate non-monetary assets and liabilities into the currency of the country of the parent company. current rate method applies the current exchange rate to all balance sheet accounts. Explanation The current rate method applies the current exchange rate to all balance sheet accounts except for common stock, which is translated at a historical rate. (Module 10.4, LOS 10.e) Question #12 of 82 Question ID: 1472545 The Herlitzka Company, a U.S. multinational firm, has a 100% stake in a Swiss subsidiary. The Swiss franc (SF) has been determined to be the functional currency. All the common stock of the subsidiary was issued at the beginning of the year and the subsidiary uses the FIFO inventory cost-flow assumption. In addition, the value of the SF is as follows: Beginning of year $0.5902 Average throughout the year $0.6002 End of year $0.6150 The SF-based balance sheet and income statement data for the Swiss subsidiary are as follows: Accounts receivable = 3,000 Inventory = 4,000 Fixed assets = 12,000 Accounts payable = 2,000 Long-term debt = 5,000 Common stock = 10,000 Retained earnings = 2,000 Net income = 2,000 The translated value of accounts receivable and inventory respectively are: A) $1,845 and $2,401. B) $1,801 and $2,401. C) $1,845 and $2,460. Explanation The basis for using the current rate method is when Functional Currency is NOT the same as Parent's Presentation (reporting) Currency. The basis for using the temporal method is when Functional Currency = Parent's Presentation Currency. Since the SF is the functional currency, then the current rate method is employed to translate the SF amounts into USD. Hence, A/R = 0.615 × 3,000 = $1,845 and 0.615 × 4,000 = $2,460. (Module 10.6, LOS 10.f) Question #13 of 82 Question ID: 1472498 A Canadian firm owns a foreign subsidiary in the U.S. In 2002, sales were USD1,000,000 and the USD/CAD exchange rate was 0.6329. In 2003, sales were also USD1,000,000 but the exchange rate was 0.7484. What is the impact of the change in the value of the CAD on the parent company's translated sales? Sales will: A) decrease by 18%. B) decline by 15%. C) increase by 18%. Explanation While sales were flat at USD 1,000,000 in local currency terms, after translation the parent firm would report sales of CAD 1,336,184 for 2003 (= USD 1,000,000 / 0.7484) versus sales of CAD 1,580,028 for 2002 (= USD 1,000,000 / 0.6329). The 15% sales decline reported by the Canadian firm (CAD 1,336,184 versus CAD 1,580,028) is a flow effect. Even though there was no sales growth in the subsidiary, the parent firm still shows a 15% decrease in revenues from the subsidiary due solely to exchange rate effects. Note that because the subsidiary sales are constant the total exchange rate effect can be measured as (0.6329 / 0.7484) − 1 = −0.15. (Module 10.2, LOS 10.c) Question #14 of 82 A hyperinflationary economy is typically defined as one that has: Question ID: 1472569 A) cumulative inflation that exceeds 100% over a three-year period. B) an inflation rate that exceeds 10% per year for three consecutive years. C) cumulative inflation that exceeds 100% over a twelve-year period. Explanation The typical definition is that cumulative inflation exceeds 100% over a three-year period. (Module 10.7, LOS 10.g) Question #15 of 82 Question ID: 1472544 Portinta Inc, a U.S. based pharmaceutical company, has a UK based subsidiary, Medaze plc. The U.S. dollar has been appreciating relative to GBP over the past year. Using the currentrate method to translate a foreign subsidiary's financial statements to U.S. dollars will most likely have which of the following effects on the long-term debt to equity ratio relative to what the ratio would have been without the effects of translation? A) The ratio will be lower. B) The ratio will be higher. C) The ratio will be the same. Explanation Under the current rate method, both LTD and equity are translated at the current rate of exchange. Hence, since the same rate is applied in both the numerator and denominator, the ratio will not change. Note: When equity is broken out into separate accounts, common stock is taken at the historical rate. When taken as a whole, equity should be translated at the current rate. In this case we are not given any information on the common stock amount, so we translate equity at the current rate. (Module 10.6, LOS 10.f) Question #16 of 82 Question ID: 1472573 Organic growth in sales is most accurately defined as growth in sales excluding the effects of: A) acquisitions/divestitures only. B) acquisitions/divestitures and currency value fluctuations. C) currency value fluctuations. Explanation Organic growth in sales is defined as growth in sales excluding the effects of acquisitions/ divestitures and currency effects. (Module 10.8, LOS 10.i) Question #17 of 82 Question ID: 1472561 Which example least accurately describes pure balance sheet and income statement ratios? A) The current ratio is a pure balance sheet ratio. B) When multiplying both the numerator and denominator by the current exchange rate, the current rate is cancelled. C) All pure balance sheet ratios are affected by the all-current translation method. Explanation All pure balance sheet ratios are unaffected by the all-current translation method. (Module 10.6, LOS 10.f) Question #18 of 82 Question ID: 1472558 Which of the following statements concerning the translation of a subsidiary's financial statement and the subsidiary's ratios is least accurate? A) B) The subsidiary's ratios in the local currency will differ from ratios calculated after translation. Ratios calculated under the current rate method will not differ from those calculated under the temporal method. C) The statement of cash flows is not affected by the choice of translation. Explanation Ratios calculated under the current rate method will differ from those calculated under the temporal method. (Module 10.6, LOS 10.f) Question #19 of 82 Question ID: 1472506 Under the current rate method, common stock is translated by using the: A) present value of weighted average rate. B) rate that existed when the equity was issued. C) exchange rate as of the balance sheet date. Explanation The historical rate is used. (Module 10.3, LOS 10.e) Question #20 of 82 Question ID: 1477070 Which of the following ratios is unaffected by the choice between the current rate method and the temporal method? A) Current ratio. B) Inventory turnover. C) Quick ratio. Explanation All of the components of the quick ratio (cash and cash equivalents, accounts receivable, and accounts payable) are converted at the same rate under both methods so the ratio is unaffected by the method. The current ratio is the same as the quick ratio except it also contains inventory which is translated at the historical rate with the temporal method and at the current rate with the current rate method. Inventory turnover ratio and current ratio both would be similarly affected as they rely on the value of inventory. (Module 10.6, LOS 10.f) Question #21 of 82 Question ID: 1472539 Regarding the different methods of consolidating foreign subsidiaries' operating results, it would be most accurate to state that: A) B) C) under the temporal method, monetary assets and monetary liabilities are translated at a historical exchange rate. under the current rate method, revenues and expenses are translated at the exchange rate that existed when the underlying transaction occurred. under the current rate method, individual components of stockholder’s equity are translated at the current exchange rates. Explanation Under the current rate method, revenues and expenses are translated at the exchange rate that existed when the underlying transaction occurred. (Though, for practical reasons, an average exchange rate is often used to translate income items.) Under the temporal method, monetary assets and monetary liabilities are translated at the current exchange rate. Under the current rate method, while shareholder's equity (as a whole, including CTA) is translated at the current rate, common stock is translated at historical exchange rate. (Module 10.5, LOS 10.e) Question #22 of 82 Question ID: 1472548 Where does the currency translation gain or loss appear in the financial statements under the temporal method and the current rate method? Temporal Current rate method method A) Balance sheet B) Income statement C) Balance sheet Balance sheet Balance sheet Income statement Explanation Currency translation gain or loss appears on the income statement under the temporal method and the balance sheet under the current rate method. (Module 10.6, LOS 10.f) Question #23 of 82 Question ID: 1472574 A company is exposed to foreign exchange risk due the impact of changes in currency values on a: A) company’s assets only. B) company’s assets and liabilities only. C) company’s assets, liabilities, and future sales. Explanation Foreign exchange risks include the impact of changes in currency values on assets and liabilities of a business, as well as on future sales. (Module 10.8, LOS 10.j) Question #24 of 82 Question ID: 1472503 Which of the following statements is least accurate regarding the use of the temporal method for foreign exchange accounting? A) All monetary assets are translated at the current rate of exchange. B) C) All nonmonetary assets and liabilities are translated at the historical rate of exchange. Under the temporal method, the foreign exchange gain or loss is placed on the balance sheet in the equity section. Explanation Under the temporal method, the foreign exchange gain or loss is placed on the income statement. (Module 10.3, LOS 10.e) South Seas Inc, a subsidiary of Seven Seas Inc., reported its most recent performance in its local currency (LC) which is the functional currency. The reporting currency of Seven Seas is the U.S. dollar (USD). South Seas also paid a dividend of 16,000LC at year end, at which time the exchange rate was 2 LC/USD. Last year, Seven Seas reported balance sheet retained earnings of 90,000 USD for its South Seas subsidiary. Rates LC/US$ Current rate 2.00 Average rate 2.20 Historical rate for common stock 2.50 Historical rate for COGS 2.30 Historical rate for depreciation 2.10 Historical rate for ending inventory 2.30 Historical rate for fixed assets 2.10 LC Revenues 520,000 Cost of Goods Sold (COGS) 225,000 SG&A 100,000 Depreciation 80,000 Income Taxes 46,000 Net Income 69,000 The balance sheet for South Seas is given below. LC Cash 25,000 Accounts Receivable 30,000 Inventory 35,000 Net Fixed Assets 500,000 Total Assets 590,000 Accounts Payable 20,000 Long term debt 100,000 Common Stock 250,000 Retained Earnings 220,000 Total Liabilities & Equity 590,000 Question #25 - 28 of 82 Question ID: 1472517 What is the amount of income Seven Seas should report from its South Seas subsidiary? A) 34,500 USD. B) 31,400 USD. C) 27,600 USD. Explanation The current rate method is used when the Functional Currency is NOT the same as the Parent's Presentation (reporting) Currency. The temporal method is used when the Functional Currency = the Parent's Presentation Currency. LC Conversion USD Revenues 520,000 /2.20 236,364 average rate COGS 225,000 /2.20 102,273 average rate SG&A 100,000 /2.20 45,455 average rate Depreciation 80,000 /2.20 36,364 average rate Income Taxes 46,000 /2.20 20,909 average rate Net Income 69,000 31,364 (Module 10.4, LOS 10.d) Question #26 - 28 of 82 Question ID: 1472518 The currency translation adjustment that results from the translation of South Sea's data is closest to? A) Zero because there is no currency translation adjustment under the current rate method. B) −3,300 USD. C) 21,600 USD. Explanation LC Conversion USD Cash 25,000 /2.00 12,500 current rate Accounts Receivable 30,000 /2.00 15,000 current rate Inventory 35,000 /2.00 17,500 current rate Net Fixed Assets 500,000 /2.00 250,000 current rate Total Assets 590,000 Accounts Payable 20,000 /2.00 10,000 current rate Long Term Debt 100,000 /2.00 50,000 current rate Common Stock 250,000 /2.50 100,000 historical rate Retained Earnings 220,000 113,364 Note 1 21,636 plug Translation Adjustment Total Liabilities & Equity 590,000 295,000 295,000 Note 1: Ending RE = Beginning RE (given USD 90,000) + NI (calculated 31,364) – Div (16000/2 = 8000) = USD 113364 (Module 10.4, LOS 10.d) Question #27 - 28 of 82 If the temporal method is used, the retaining earnings is closest to: A) 21,600 USD. B) 120,800 USD. C) 90,000 USD. Explanation Question ID: 1472519 The retained earnings value is the plug figure. The value of total assets is $280,813. Subtracting the accounts payable, long-term debt, and common stock from the total assets leaves $120,813. LC Conversion USD Cash 25,000 /2.00 12,500 current rate Accounts Receivable 30,000 /2.00 15,000 current rate Inventory 35,000 /2.30 15,217 historical rate for inventory Net Fixed Assets 500,000 /2.10 238,095 historical rate for fixed assets Total Assets 590,000 Accounts Payable 20,000 /2.00 10,000 current rate Long Term Debt 100,000 /2.00 50,000 current rate Common Stock 250,000 /2.50 100,000 historical rate Retained Earnings 220,000 120,813 280,813 − 10,000 − 50,000 − 100,000 Total Liabilities & Equity 590,000 280,813 280,813 (Module 10.4, LOS 10.d) Question #28 - 28 of 82 Question ID: 1472520 If the functional currency is the US$ then the net income before a remeasurement is closest to: A) 8,000 USD. B) 4,700 USD. C) 34,100 USD. Explanation Adjust the income statement by the appropriate rates. For COGS and depreciation, historical rates were given. Average rate is used for all others. LC Conversion USD Revenues 520,000 /2.20 236,364 average rate COGS 225,000 /2.30 97,826 historical rate for COGS SG&A 100,000 /2.20 45,455 average rate Depreciation 80,000 /2.10 38,095 historical rate for depreciation Income Taxes 46,000 /2.20 20,909 average rate Net Income before remeasurement 69,000 34,079 (Module 10.4, LOS 10.d) Question #29 of 82 Question ID: 1472565 Under U.S. GAAP, the temporal method is preferred to the current rate method in hyperinflationary economies because the temporal method: A) results in non-monetary asset values that are a better proxy for the economic values of those assets. B) is easier to perform under hyperinflation. C) provides better conversions of subsidiary revenues. Explanation The temporal method results in non-monetary asset values that are a better proxy for the economic values of those assets than those obtained under the current rate method. Both methods convert revenues and SG&A at the average rate so there could be no clear preference when considering these measures. (Module 10.7, LOS 10.g) Question #30 of 82 Question ID: 1472570 (Assume U.S. GAAP for this question.) For a subsidiary in a hyperinflationary economy, the functional currency should be the: A) Parent's currency. B) Local currency. C) Subsidiary's operating currency. Explanation The functional currency should be the parent's currency. Under IFRS, the firm would restate the financials for inflation, and then translate under the current rate method. (Module 10.7, LOS 10.g) Question #31 of 82 Question ID: 1472537 The U.S. Deter Company operates a subsidiary in the UK, and the functional currency is the British pound. The subsidiary's 2001 income statement shows £500 of net income and a £50 dividend that was paid on December 31, when the exchange rate was $1.50 per pound. The current exchange rate is $1.65 per pound, and the average rate is $1.58 per pound. What is the change in retained earnings for the period in U.S. dollars under U.S. GAAP? A) $750. B) $725. C) $715. Explanation The basis for using the current rate method is when Functional Currency is NOT the same as Parent's Presentation (reporting) Currency. The basis for using the temporal method is when Functional Currency = Parent's Presentation Currency. Since the functional currency is the local currency, use the current rate method. The net income is translated at the average rate, and dividends are translated at the rate that applied when they were paid. Hence: 1.58(£500) − 1.50(£50) = $715. (Module 10.4, LOS 10.e) Question #32 of 82 Question ID: 1472568 In reality, what best describes the real value of non-monetary assets and liabilities in a hyperinflationary environment? A) All non-monetary accounts are re-measured at the current rate. B) C) Typically not affected because their local currency-denominated values increase to offset the impact of inflation. Typically not affected because their local currency-denominated values decrease to offset the impact of inflation. Explanation Typically not affected because their local currency-denominated values increase to offset the impact of inflation (i.e., real estate values typically rise with inflation). (Module 10.7, LOS 10.g) Question #33 of 82 Question ID: 1472551 Which of the following statements regarding the effects of translation on financial statement items/ratios is most accurate? A) B) C) Depreciation in the reporting currency under the current rate method is higher than under the temporal method if the local currency has appreciated. Fixed assets are relatively overstated under the temporal method compared to the local currency if the local currency has appreciated. Leverage is higher under the current rate method as compared to under the local currency. Explanation Fixed assets are relatively understated under the temporal method if the local currency appreciates as they are translated at the weaker historic rate. The leverage ratio will be unaltered under the current rate method as it is a pure balance sheet ratio and hence all translated at the current rate. (Module 10.6, LOS 10.f) Question #34 of 82 Question ID: 1472563 The Precision Screen Printers (PSP) Company has a foreign subsidiary, the Acer Tool & Die Company, located in the country of Rolivia. The currency of Rolivia is the Chad. The balance sheet and income statement of Acer Tool & Die Company for the year-ended December 31, 20X2, is shown below. The balance sheet has been restated using the U.S. dollar as the functional currency. Acer Tool & Die Company Balance Sheet As of December 31, 20X2 Chad Exchange Rate U.S. $ (millions) (Chad/US$) (millions) Cash 20 0.25 $80 Accounts receivable 30 0.25 120 Inventory 100 0.3125 320 Fixed assets (net) 500 0.3333 1,500 Total assets 650 Accounts payable $2,020 50 0.25 $200 Capital stock 380 0.3333 1,140 Retained earnings 220 -- 680 Total liabilities and equity 650 $2,020 Acer Tool & Die Company Income Statement For year ending December 31, 20X2 (Amounts in millions of Chad) Revenues Cost of sales 1,000 700 Depreciation expense 50 Selling expense 30 Translation gain (or loss) Net income 220 The exchange rate at the beginning of 20X2 was 0.3333 Chad/US$. The exchange rate at the end of 20X2 was 0.25 Chad/US$. The average rate for 20X2 is 0.3125 Chad/US$. Beginning inventory is 90 Chad, which was translated to $270 on the 20X1 balance sheet. Acer Tool & Die uses FIFO inventory valuation and depreciates fixed assets using the straight-line method. Purchases occurred evenly throughout the year. Assume that retained earnings at year-end 20X1 were zero, the historical exchange rate for depreciation is 0.333, and no dividends were paid during 20X2. Using the current rate method for the Acer Tool & Die Company, what is the value of total assets after translation? A) $1,950. B) $2,020. C) $2,600. Explanation With the current rate method, all balance sheet items except for common stock are translated at the current rate. Total assets = 650 / 0.25 = $2,600. (Module 10.6, LOS 10.f) Question #35 of 82 Question ID: 1472540 Gortal Inc., a U.S. company has a wholly owned subsidiary, Fortina GmBh, based in Germany. The U.S. dollar has been appreciating relative to the Euro over the past year. The use of the temporal method to translate a foreign subsidiary's financial statements to U.S. dollars will most likely have which of the following effects on the fixed-asset turnover ratio (S/FA) relative to what the ratio would have been without the effects of translation assuming no new fixed assets were purchased throughout the year? A) The ratio will be lower. B) There will be no effect on the ratio. C) The ratio will be higher. Explanation Since the dollar has appreciated, the local currency has depreciated, so each foreign currency unit bought more dollars in the past relative to the present. Fixed assets are remeasured at the historical rate and sales are remeasured at the average rate under the temporal method. Since the historical rate is buying more dollars relative to the average rate, the denominator is staying the same whereas the numerator is getting smaller. Thus, the ratio is lower. (Module 10.6, LOS 10.f) Question #36 of 82 Question ID: 1472497 A German company (reporting currency = Euro) owns a foreign subsidiary in the U.S. If the results below are reported in local currency (USD), after translation what is the effect of the change in the exchange rate on revenues? Round to the nearest dollar and/or percent. $ per 1 Euro avg. Year Sales 2001 $10,000 0.9 2002 $10,000 0.8 Exchange Rate A) The company shows a 0.1% decline in revenues in 2002. B) The company shows a 12.5% growth in revenues in 2002. C) There is no change is revenue growth between 2001 and 2002. Explanation While sales were flat in terms of local currency, after translation the reported revenue increased 12.5%. 10,000/0.9 = 11,111; 10,000/0.8 = 12,500; 12,500/11,111 = 12.5% increase due to exchange rate effects. (Module 10.2, LOS 10.c) Question #37 of 82 Question ID: 1472541 The Herlitzka Company, a U.S. multinational firm, has a 100% stake in a Swiss subsidiary. The U.S. dollar (USD) has been determined to be the functional currency. All the common stock of the subsidiary was issued at the beginning of the year and the subsidiary uses the weighted-average inventory cost-flow assumption. In addition, the value of the SF is as follows: Beginning of year $0.5902 Average throughout the year $0.6002 End of year $0.6150 The SF-based balance sheet and income statement data for the Swiss subsidiary are as follows: Accounts receivable = 3,000 Inventory = 4,000 Fixed assets = 12,000 Accounts payable = 2,000 Long-term debt = 5,000 Common stock = 10,000 Retained earnings = 2,000 Net income = 2,000 The total value of net monetary assets is equal to: A) 3,000 SF. B) 12,000 SF. C) -4,000 SF. Explanation Monetary assets and liabilities include cash, A/R, A/P and Long-term debt. Hence, net monetary assets is equal to 3,000 − (2,000 + 5,000) = -4,000 SF. (Module 10.6, LOS 10.f) Question #38 of 82 Question ID: 1472507 Which of the following currency translation methods is most appropriate in a hyperinflationary economy under US GAAP? The: A) B) C) temporal method because all non-monetary accounts are translated at the historical rate. current/non-current method since current assets and liabilities are translated at the current exchange rate. current rate method since the translation gain or loss is shown on the income statement. Explanation The temporal rate method is most appropriate because the value of non-monetary assets and liabilities is translated at the historical rate. Under IFRS, the firm restates the financials using an inflation index, and then translates using the current rate method. (Module 10.3, LOS 10.e) Question #39 of 82 Question ID: 1472489 Which of the following statements regarding the functional currency is least accurate? The functional currency: A) is the currency of the primary economic environment in which the foreign subsidiary generates and expends cash. B) is determined by management. C) is remeasured into the reporting currency under the temporal method. Explanation The basis for using the current rate method is when Functional Currency is NOT the same as Parent's Presentation (reporting) Currency. The basis for using the temporal method is when Functional Currency = Parent's Presentation Currency. The local currency is remeasured into the functional currency under the temporal method. The functional currency is translated into the reporting currency using the current rate method. (Module 10.1, LOS 10.a) Question #40 of 82 Question ID: 1482619 The Schuldes Company had the following reported assets in euros at historical cost for the period ending December 31, 2005. Cash 134 Accounts receivable 270 Inventory 404 Net fixed assets 1347 Total assets 2155 The exchange rate per euro was $0.8734 on January 1, 2005 and $0.9896 on December 31, 2005. The average exchange rate for the year 2005 was $0.8925. The total assets of Schuldes using the current rate method are: A) $2,178. B) $1,923. C) $2,133. Explanation With the current rate method all balance sheet items except common stock use the current exchange rate to translate the functional currency into the reporting currency. 2155 × $0.9896 = $2,133. (Module 10.6, LOS 10.f) Question #41 of 82 Question ID: 1472547 Hann Company is a U.S. multinational firm with operations in several foreign countries. Hann has a 100% stake in a French subsidiary. The foreign subsidiary's local currency has appreciated against the U.S. dollar over the latest financial statement reporting period. In addition, the French firm accounts for inventories using the first in, first out (FIFO) inventory cost-flow assumption. The gross profit margin as computed under the current rate method would most likely be: A) equal to the gross profit margin as computed under the temporal method. B) higher than the gross profit margin as computed under the temporal method. C) lower than the gross profit margin as computed under the temporal method. Explanation The average rate is used to convert sales under both the temporal method and the current rate method. Hence, the only difference between the two computations is on cost of goods sold (COGS). Since the firm uses FIFO, older materials are flowing into COGS and an older exchange rate applies. Since in the past the foreign currency bought fewer dollars, the gross profit under the temporal method will be higher than that of the current rate method. It may help to 'think' that with the current rate method, you use the average rate for COGS, which makes COGS higher because the currency has appreciated. (Module 10.6, LOS 10.f) Question #42 of 82 Question ID: 1472564 In a hyperinflationary economy, translation under the current rate method will most likely result in relatively: A) low balance sheet values for long term liabilities. B) high balance sheet values for long term assets. C) high translation gains. Explanation In a hyperinflationary economy, translation under the current rate method will most likely result in relatively low balance sheet values for assets and liabilities. Translation losses will also occur. (Module 10.7, LOS 10.g) Question #43 of 82 Question ID: 1472495 Sycamore Systems sold $5 million worth of software on December 1, 20X1 to a Japanese company with payment denominated in Japanese yen to be received in two months. Sycamore's year end is 31st December. Payment was received on 31 Jan 20X2. Exchange rates (1 USD) 1 Dec 20X1 95 31 Dec 20X1 90 31 Jan 20X2 35 The amount of transaction gain/loss recorded by Sycamore on its income statement for the year ending 31 Dec 20X1 is closest to: A) loss of $300,000. B) gain of $580,000. C) gain of $280,000. Explanation Sale amount = $5 million × 95 = 475 million yen. Accounts receivable on sale date = $5 million. Accounts receivable at year-end = 475 million yen/90 = $5.28 million The appreciation of the yen resulted in a gain of $280,000 on the balance sheet date and would be recognized in the income statement. (Module 10.1, LOS 10.b) Question #44 of 82 Question ID: 1472501 Which of the following general statements is most accurate with respect to the temporal method? Nonmonetary assets are translated at: A) historical rates at the time of the transaction. B) the average rate during the year. C) the current rate. Explanation As a general rule in using the temporal method, nonmonetary assets are translated using the historical rate at the time of the transaction. (Module 10.3, LOS 10.e) Question #45 of 82 Question ID: 1472546 Which of the following ratios is affected by translation under the current rate method? A) Debt/Assets ratio. B) Fixed asset turnover ratio. C) Net profit margin. Explanation Recall that all pure income statements and balance sheet ratios are unaffected by translation under the current rate method. The fixed asset turnover ratio is not a pure ratio; it consists of an income statement measure (sales, translated at the average rate) and a balance sheet measure (fixed assets, translated at the current rate). (Module 10.6, LOS 10.f) Deborah Ortiz, CFA®, is the director of Global Research for F.E. Horton & Co. Ortiz recently hired two junior analysts, Tina Hirauye and Dominique Wilkins to assist in the financial statement analysis of global conglomerates. Hirauye and Wilkins are both Level II candidates in the CFA® Program, so Ortiz thought they would be the ideal people to work on a project dealing with consolidating the results of foreign operating units in the financial statements of the global parent. Before starting on the project, Ortiz has a meeting with Hirauye and Wilkins to discuss the use of different currencies in a company's operations. At the meeting, Hirauye states that when analyzing multinational firms, there cannot be a difference between local and functional currencies. Wilkins disagrees with her and states that there can be a difference between local and functional currencies, but only if the parent of the subsidiary operates in a hyperinflationary environment. After another 30 minutes of discussion, Ortiz concludes the meeting by telling them to make sure they understand the different accounting rules for remeasurement and translation, under SFAS 52. Hirauye and Wilkins are given projects involving two different firms: Molsan Industries is a Canadian multinational firm with a subsidiary in Japan. The subsidiary has operations in both Japan and Singapore. Neslarone is based in Switzerland and generates the majority of its cash in Swiss Francs (CHF). The firm issues and prepares its consolidated financial statements in U.S. dollars. Hirauye and Wilkins spend the morning reviewing the details of their assignment and decide to take a break for lunch at a restaurant across the street from F.E. Horton & Co.'s headquarters. They agree that they have a challenging task and both are nervous about turning in their consolidated financial statements to Ortiz on the following day. Question #46 - 49 of 82 Regarding the statements made at the meeting: A) Hirauye’s statement is incorrect; Wilkins’ statement is correct. B) Hirauye’s statement is incorrect; Wilkins’ statement is incorrect. Question ID: 1472491 C) Hirauye’s statement is correct; Wilkins’ statement is correct. Explanation The basis for using the current rate method is when Functional Currency is NOT the same as Parent's Presentation (reporting) Currency. The basis for using the temporal method is when Functional Currency = Parent's Presentation Currency. Hirauye and Wilkins both make incorrect statements regarding local and functional currencies. A foreign subsidiary may have a local currency but designate another currency as its functional currency. The functional currency is defined as the currency of the primary environment in which the subsidiary generates and expends cash, but the choice of the functional currency is ultimately a function of management's judgment. Wilkins is also incorrect because the rate of inflation does not necessarily have an impact on designated currencies. (Module 10.1, LOS 10.a) Question #47 - 49 of 82 Question ID: 1472492 Hirauye is working on consolidating the financial statements of Molsan Industries' Japanese subsidiary. Under SFAS 52, regarding Foreign Currency Translation, if: more than half of the subsidiary's revenue is from Japanese sources, then the A) results of the Singapore operation are translated into Japanese yen and then translated into Canadian dollars. management determines that the subsidiary's functional currency is the B) Japanese yen, the results of the Singapore operation are first remeasured into Japanese yen and then translated into Canadian dollars. management determines that the subsidiary's functional currency is the C) Singapore dollar, then the results of the Singapore operation are remeasured into Canadian dollars. Explanation The functional currency is determined by management. Financial data are remeasured into the functional currency chosen by management and then translated into the reporting currency. (Module 10.1, LOS 10.a) Question #48 - 49 of 82 Question ID: 1472493 Ortiz had told the junior analysts to make sure they understand the different accounting rules under SFAS 52. When referring to foreign exchange rates, the difference between remeasurement and translation is that remeasurement: refers to the conversion of local currency into the functional currency; A) translation is the conversion of the functional currency into the reporting currency. B) C) and translation refer to the same process of translating the functional currency into the reporting currency. is used to describe historical exchange rates while translation is used for current rates. Explanation Translation is between functional and reporting currency. Remeasurement occurs between local and functional currencies. (Module 10.1, LOS 10.a) Question #49 - 49 of 82 Question ID: 1472494 Wilkins and Hirauye are working on constructing the consolidated statements for Neslarone. They know that after they convert from Swiss Francs (CHF) to U.S. dollars (USD), they will be left with a foreign currency adjustment that needs to be included on the financial statements. To convert from CHF to USD, the analysts should use the: A) B) C) current rate method and they should record the foreign currency adjustment on the balance sheet. current rate method and they should record the foreign currency adjustment on the income statement. temporal method and they should record the foreign currency adjustment on the income statement. Explanation Neslarone is based in Switzerland and generates the majority of its cash in CHF, meaning the local and functional currencies are both CHF. The firm issues financial reports in USD, so the dollar is the reporting currency. The process of converting from the functional currency to the reporting currency is translation and the correct method to use is the current rate method. When using the current rate method, the foreign currency adjustment is recorded in the equity section of the balance sheet. (Module 10.1, LOS 10.a) Question #50 of 82 Question ID: 1472530 At what exchange rate are revenues and accounts receivable translated under the current rate method? Accounts Revenues receivable A) Average rate Current rate B) Current rate Current rate C) Average rate Historical rate Explanation Under the current rate method, revenues are translated at the average rate; accounts receivable are translated at the current rate. (Module 10.4, LOS 10.e) Question #51 of 82 Question ID: 1472508 Dave Iverson, CFA, is analyzing the recently released financial statement of Global Corp., a large multinational manufacturing company with production facilities across Europe and Southeast Asia. The company's choice of functional currency is not disclosed, but Iverson does notice that Global Corp. does not have any cumulative translation adjustments (CTA) on its balance sheet. Which of the following statements is most accurate based upon Iverson's observation? A) The temporal method of foreign currency translation is used for at least some of its subsidiaries. B) The current rate method of foreign currency translation is used exclusively. C) The temporal method of foreign currency translation is used exclusively. Explanation The choice of functional currency is the determining factor as to which method of foreign currency translation is utilized. If no CTA appears on the balance sheet, then the parent currency must be the functional currency for all of the company's subsidiaries and only the temporal method is used. (Module 10.3, LOS 10.e) Question #52 of 82 Question ID: 1472526 Which of the following statements regarding the foreign currency translation under US GAAP is least accurate? The functional currency is the: A) subsidiary's local currency for self-contained, independent foreign subsidiaries. B) C) parent firm's home currency if the foreign subsidiary operates in a country with high inflation. parent firm's home currency for self-contained independent foreign subsidiaries. Explanation The basis for using the current rate method is when Functional Currency is NOT the same as Parent's Presentation (reporting) Currency. The basis for using the temporal method is when Functional Currency = Parent's Presentation Currency. This statement is incorrect, both remaining statements are correct regarding rules that govern the determination of the functional currency of subsidiaries. (Module 10.4, LOS 10.e) Question #53 of 82 Question ID: 1472509 Each of the following items is considered a monetary asset or liability account under the temporal method for foreign currency translation EXCEPT: A) long-term debt. B) accounts payable. C) inventory. Explanation The monetary asset and liability accounts under the temporal method are cash, accounts receivable, accounts payable, and long-term debt. (Module 10.3, LOS 10.e) Question #54 of 82 Question ID: 1472555 The U.S. dollar (i.e., the reporting currency) has been depreciating relative to the local currency over the past year. The use of the current rate method to translate a foreign subsidiary's financial statements to U.S. dollars will most likely have which of the following effects on return on equity (ROE) based on ending equity relative to what the ratio would have been without the effects of translation? A) ROE will most likely rise. B) ROE will most likely decline. C) The impact of the depreciation of the US dollar on ROE is indeterminate. Explanation ROE = Net Income / Equity. Under the current rate method, the equity accounts as a whole are translated at the current rate whereas net income is translated at the average rate. Since the dollar is depreciating, each foreign currency unit is buying more dollars in the denominator relative to the numerator of the equation. Hence, the denominator is increasing and the ratio falls. (Module 10.6, LOS 10.f) Question #55 of 82 Question ID: 1472496 A U.S. firm owns a foreign subsidiary in France. In 2002, sales were EUR 1,000,000 and the USD/EUR exchange rate was 1.0620. In 2003, sales were EUR 1,100,000 and the exchange rate was 1.1417. What is the impact of the change in the value of the USD on the parent company's translated sales? A) Sales will decrease by 7.5%. B) Sales will increase by 18.25%. C) Sales will increase by 7.5%. Explanation The increase in sales due to the appreciating EUR is measured as 7.5% [= (1.1417 / 1.0620) − 1]. Sales for the subsidiary rose 10% [= (1,100,000 / 1,000,000) – 1] in the local currency (EUR). After translation the parent firm will report sales of USD 1,062,000 (= EUR 1,000,000 × 1.0620) for 2002 and USD 1,255,870 (= EUR 1,100,000 × 1.1417) for 2003. Growth measured from the parent's perspective suggests sales rose 18.25% [= (1,255,870 / 1,062,000) − 1], but this includes the growth rate in sales measured in the local currency and the rate of appreciation in the foreign currency, or (1.10 × 1.075) − 1 = 0.1825. The question only asks for the impact of the change in the value of the USD. (Module 10.2, LOS 10.c) Question #56 of 82 Question ID: 1472488 Which of the following statements describing the choice of the functional currency is least accurate? The functional currency should be the same as the parent's reporting currency if the subsidiary is: A) B) highly integrated with the parent where the local currency, prices, and some costs are controlled or restricted. highly integrated with the parent where the local currency, prices, and some costs are not controlled or restricted. C) mostly independent from the parent. Explanation The preferred functional currency for subsidiaries that are mostly independent of the parent is the local currency. For highly integrated subsidiaries (regardless of local conditions), or for subsidiaries operating in high-inflation environments, the parent's reporting currency should be used as the functional currency. (Module 10.1, LOS 10.a) Question #57 of 82 Question ID: 1472562 Which of the following measures is unaffected by the choice between translation under the current rate method and remeasurement under the temporal method? A) Tax expense. B) Cost of goods sold. C) Equity. Explanation Taxes are converted at the same rate (average rate) under both methods. Equity under the temporal method is a mixed rate whereas under the current rate method it is at the current rate. COGS under the temporal method is at the historical rate and under the current rate method it is at the average rate. (Module 10.6, LOS 10.f) Wasson Brothers (WB) is a large U.S. based conglomerate with many subsidiaries in both the U.S. and abroad. One of WB's wholly-owned foreign subsidiaries, Kasamatsu Industries, is based in Japan. Kasamatsu manufactures a hugely successful line of trading cards, toys, and related products. All of Kasamatsu's operations and sales take place in Japan, and the corresponding transactions are denominated in Japanese yen. Additionally, Kasamatsu's books and records are all maintained in yen. WB reports its earnings in U.S. dollars. The history of the exchange rate between the dollar and the yen over the last two years is presented in the following table. Figures are presented in yen/$. Yen/Dollar Exchange Rate December 31, 2013 150 December 31, 2012 130 2013 Average 140 2012 Average 120 Exchange rate on date that 2013 dividends were declared by Kasamatsu Exchange rate on date of stock issue and acquisition of fixed assets. 145 100 Shelly Jameson is an analyst with Henderson-Wells, an investment banking firm in New York, and is the chief analyst covering WB. She believes that the enormous success of the trading cards has contributed greatly to WB's bottom line. However, Jameson believes that this effect may be misstated in the company's financial statements because of the recent volatility in exchange rates. Many analysts at other investment banking firms have been raising their ratings on WB because of the recent earnings growth. Jameson, however, wants to be absolutely certain that these results are accurate and fully attributable to Kasamatsu's hot new product and not a result of an exchange rate fluctuation. The following are the financial statements of Kasamatsu, stated in thousands of yen. Financial Statements for Year Ending December 31, 2013 (in thousands of yen) Statement of Income and Retained Earnings Sales 700,000 Expenses Cost of Goods Sold (COGS) 280,000 Depreciation 126,000 SG&A 77,000 Total Expenses 483,000 Earnings Before Taxes (EBT) 217,000 Income Tax Expense 98,000 Net Income 119,000 Retained Earnings: December 31, 2012 250,000 369,000 Dividends 58,000 Retained Earnings: December 31, 2013 * 311,000 * Retained earnings on 12/31/2013 were US $2 million Balance Sheet Assets Cash and receivables 60,000 Inventory 180,000 Land 200,000 Fixed assets 346,000 Total assets 786,000 Liabilities and stockholders' equity Liabilities 300,000 Capital stock 175,000 Retained earnings 311,000 Total liabilities and stockholders' equity Question #58 - 61 of 82 786,000 Question ID: 1472522 Jameson would like to examine WB's group accounts. What is the most appropriate exchange rate (yen/$) to use in translating Kasamatsu's reported dividends into U.S. dollars? A) 150. B) 140. C) 145. Explanation Dividends are translated at the exchange rate that existed on the dividend declaration date. (Module 10.4, LOS 10.d) Question #59 - 61 of 82 Question ID: 1472523 If Jameson wishes to convert any of the figures on Kasamatsu's Income Statement from yen to dollars, she should most appropriately use which of the following exchange rates (yen/$)? A) 140. B) 145. C) 150. Explanation Under the current rate method, all items in the income statement would be translated at the average rate or 140JPY/USD. Because this question is asking only for translating sales, the average rate would be used even under the temporal method. (Module 10.4, LOS 10.d) Question #60 - 61 of 82 Question ID: 1472524 Jameson has finally completed translating all the necessary figures into dollars and now wants to compute by how much WB's reported sales in dollars will change due to Kasamatsu's sales. Which of the following is closest to the amount of sales that WB will report as a result of Kasamatsu's operations (in thousands of dollars)? A) $4,828. B) $5,000. C) $4,667. Explanation The current rate method is used when the Functional Currency is NOT the same as the Parent's Presentation (reporting) Currency. The basis for using the temporal method is when the Functional Currency = the Parent's Presentation Currency. Because sales as a financial item is on the income statement, the 2013 average exchange rate of 140 JPY/USD must be used to calculate sales in the reporting currency. Kasamatsu's sales were JPY 700,000. The calculation is: 700,000¥ = $5, 000 140¥/$ WB will report $5,000 of sales as a result of Kasamatsu's operations. (Module 10.4, LOS 10.d) Question #61 - 61 of 82 Question ID: 1472525 Before Jameson can perform any financial statement analysis, she wants to determine which method WB uses to translate Kasamatsu's earnings into U.S. dollars (USD). Which of the following is the most accurate translation method and reasoning? WB should translate Kasamatsu's earnings using the: A) current rate method because the local currency is the USD. B) temporal method because the local currency differs from the functional currency. C) current rate method because the functional currency is the yen. Explanation The current rate method is used when the functional currency is NOT the same as parent's presentation (reporting) currency. The temporal method is used when Functional Currency = Parent's Presentation Currency. Under US GAAP the current rate method must be used to translate Kasamatsu's yen financial statements into USD, the reporting currency. Had Kasamatsu been operating in a highly inflationary environment or had the local and functional currency not been the same, then WB would be required to use the temporal method. (Module 10.4, LOS 10.d) Question #62 of 82 Question ID: 1472502 Which of the following statements regarding the translation of a foreign subsidiary into the reporting currency is most accurate? A) B) C) If the reporting currency is the functional currency, the temporal method is applied and exposure is equal to net monetary assets. A multinational firm with small liability balances generally has minimal foreign currency exposure on its balance sheet. If the functional currency is equal to the local currency, exchange gains and losses on translation will be recognized in the income statement. Explanation The choice of functional currency is the determining factor as to which method of foreign currency translation is utilized. Therefore, when the reporting currency is the functional currency, the temporal method must be used. The choice of functional currency is largely left to management's discretion. (Module 10.3, LOS 10.e) Question #63 of 82 Question ID: 1472531 Which of the following statements regarding the functional currency under US GAAP is least accurate? A) Self-contained, independent subsidiaries whose operations are primarily located in the local market will use the local currency as the functional currency. If a firm operates in a country or environment which is subject to cumulative B) inflation of 100% or more over a three year period, that firm will use the parent's currency as the functional currency. C) The functional currency is defined as the primary currency of the economic environment in which the parent firm operates. Explanation The basis for using the current rate method is when Functional Currency is NOT the same as Parent's Presentation (reporting) Currency. The basis for using the temporal method is when Functional Currency = Parent's Presentation Currency. The functional currency is defined as the primary currency of the economic environment in which the foreign subsidiary operates. (Module 10.4, LOS 10.e) Question #64 of 82 Question ID: 1472567 The nation of Deadoa is experiencing hyperinflation. A subsidiary of a multinational operating in Deadoa will notice changes in its purchasing power and in its financial results as reported on its parent company's financial statements. Which of the following best describes the situation for a subsidiary operating in Deadoa? Purchasing power will: A) B) C) dramatically appreciate and the local currency will be rapidly appreciating against the presentation currency. quickly deteriorate and the local currency will be rapidly appreciating against the presentation currency. quickly deteriorate and the local currency will be rapidly depreciating against the presentation currency. Explanation Purchasing power and Deadoa currency will depreciate. (Module 10.7, LOS 10.g) Question #65 of 82 Question ID: 1472572 Sopgate is a manufacturer of branded fast moving consumer goods having business operations in 28 countries (in each country, Sopgate has a wholly owned local subsidiary for production and/or distribution). Following information is available from Sopgate's annual report: Region Growth in pre-tax Revenue Growth (USD)* profits (USD)* Tax rate Latin America 5% 4% 25% North America 3% 3% 35% Europe 2% −1% 45% Asia pacific 4% 6% 20% *Growth rate indicates expected growth rate over the next five years. Sopgate's effective tax rate is most likely expected to: A) increase. B) decrease. C) remain unchanged. Explanation Sopgate's profits are expected to grow at a faster rate for lower tax rate regions as compared to higher tax regions. Hence the effective tax rate can be expected to decrease. (Module 10.8, LOS 10.h) Question #66 of 82 Question ID: 1472571 Which translation method should be used under a hyperinflationary economy when using U.S. GAAP? A) B) Monetary/non-monetary, because all monetary accounts are translated at the historical rate. Temporal, because all non-monetary accounts are re-measured at the historical rate. C) All-current, because dividends are translated at the rate that applied when they were issued. Explanation The temporal method is more appropriate because all non-monetary accounts are remeasured at the historical rate. Under IFRS, the financials would be restated for inflation, and then translated under the current rate method. (Module 10.7, LOS 10.g) Question #67 of 82 Question ID: 1472527 Which of the following general statements is most accurate with respect to the current rate method? Revenues: A) and operating expenses are translated at the average rate. B) and operating expenses are translated at the current rate. C) are translated at the average rate while operating expenses are translated at the current rate. Explanation As a general rule for the current rate method, all revenues and operating expenses are translated using the average rate. (Module 10.4, LOS 10.e) Question #68 of 82 Question ID: 1472557 Which of the following subsidiary ratios will be affected by the translation adjustment under the current rate method? A) Gross margin. B) Net profit margin. C) Return on equity. Explanation The translation adjustment will affect the book value of equity and therefore the return on equity ratio. The other ratios are pure ratios (both component of the ratio come from the income statement) and are not affected by translation. (Module 10.6, LOS 10.f) The Precision Screen Printers (PSP) Company has a foreign subsidiary, the Acer Tool & Die Company, located in the country of Rolivia. The currency of Rolivia is the Chad. The balance sheet and income statement of Acer Tool & Die Company for the year-ended December 31, 2005, is shown below. The balance sheet has been restated using the U.S. dollar as the functional currency. Acer Tool & Die Company Balance Sheet As of December 31, 2005 Chad Exchange Rate U.S. $ (millions) (Chad/US$) (millions) Cash 20 0.25 $80 Accounts receivable 30 0.25 120 Inventory 100 0.3125 320 Fixed assets (net) 500 0.3333 1,500 Total assets 650 Accounts payable $2,020 50 0.25 $200 Capital stock 380 0.3333 1,140 Retained earnings 220 -- 680 Total liabilities and equity 650 $2,020 Acer Tool & Die Company Income Statement For year ending December 31, 2005 (Amounts in millions of Chad) Revenues Cost of sales Depreciation expense 1,000 700 50 Selling expense 30 Translation gain (or loss) Net income 220 Acer has determined that the exchange rate exposure at the beginning of 2005 is −260 Chad. The exchange rate at the beginning of 2005 was 0.3333 Chad/US$ and that is the historical rate applicable to beginning inventory of 90 Chad. The exchange rate at the end of 2005 was 0.25 Chad/US$. The average rate for 2005 is 0.3125 Chad/US$. Purchases occurred evenly throughout the year. Acer Tool & Die uses FIFO inventory valuation and depreciates fixed assets using the straight-line method. Assume that retained earnings at year end 2004 were zero, the historical exchange rate for depreciation is 0.333, and no dividends were paid during 2005. Question #69 - 70 of 82 Question ID: 1472553 What is Acer Tool & Die's cost of sales in U.S. dollars using the temporal method? A) $2,240.00 B) $2,242.00 C) $2,222.00 Explanation Purchases = COGS − Beginning inventory + ending inventory = 710 Chad Chad Conversion US$ Beginning inventory 90 0.3333 $270 Purchases 710 0.3125 2,272 Ending inventory 100 0.3125 320 COGS 700 $2,222 (Module 10.6, LOS 10.f) Question #70 - 70 of 82 Question ID: 1472554 What is the remeasurement gain or loss for the period using the temporal method? A) $52 loss. B) $50 gain. C) $32 loss. Explanation Remeasured income statement under temporal method: Revenues = 1000/0.3125 = 3200 COGS = 2222 (from previous question) Depreciation = 50/0.3333 = 150 Selling expense = 30/0.3125 = 96 Income before remeasurement gain = 3200 − 2222 − 150 − 96 = 732 Net income = 680 (= retained earnings at year end 2005 − retained earnings at year end 2004) Remeasurement gain/loss = 680 − 732 = -52 (Module 10.6, LOS 10.f) Question #71 of 82 Question ID: 1472499 Edmonton Oilfield Supply has made an equipment sale in Venezuela in the amount of VEF 15,000,000. On the day of the sale, the exchange rate is 1.7519 VEF per 1 Canadian dollar. 90 days later, when the Venezuelan firm pays for the equipment, the exchange rate is 1.6326. As a result of the change in the exchange rate, Edmonton will recognize a: A) gain of $625,666. B) gain of $1,096,104. C) loss of $1,789,500. Explanation On the day of the sale, Edmonton will record an account receivable of 15m/1.7519 = $8,562,133. When the payment is received and converted to CAD, the realized amount will be 15m/1.6326 = $9,187,799. As a result of the appreciating VEF, Edmonton will realize a gain of $9,187,799 − 8,562,133 = CAD 625,666. (Module 10.2, LOS 10.c) Question #72 of 82 Question ID: 1472543 Quest o o 8 Question ID: 1472543 Hann Company is a U.S. multinational firm with operations in several foreign countries. Hann has a 100 percent stake in a French subsidiary. The foreign subsidiary's local currency has appreciated against the U.S. dollar over the latest financial statement reporting period. In addition, the French firm accounts for inventories using the FIFO inventory cost-flow assumption. The net profit margin as computed under the current rate method would most likely be: A) lower than the same ratio computed under the temporal method. B) either higher or lower than the same ratio computed under the temporal method. C) higher than the same ratio computed under the temporal method. Explanation The foreign currency gain or loss appears on the income statement under the temporal method. Hence, to make any determinations regarding the movements of this ratio, we need more information regarding the net monetary asset or liability position as of both the beginning and ending balance sheet date. (Module 10.6, LOS 10.f) Question #73 of 82 Question ID: 1472550 The U.S. dollar has been depreciating relative to the local currency over the past year. The use of the current rate method to translate a foreign subsidiary's financial statements to U.S. dollars will most likely have which of the following effects on the operating profit margin (EBIT/S) relative to what the ratio would have been without the effects of translation? A) There will be no effect on the ratio. B) The ratio will rise. C) The ratio will fall. Explanation Under the current rate method, the average rate is applied to all income statement accounts. Hence, since the average rate is applied to both numerator and denominator of the equation and the ratio will not change. (Module 10.6, LOS 10.f) Question #74 of 82 Question ID: 1472500 Which of the following situations does NOT require the use of the temporal method? The: A) foreign subsidiary is operating in a highly inflationary economy. B) local currency is the functional currency. C) functional currency is some currency other that the local currency or the U.S. dollar. Explanation The basis for using the current rate method is when Functional Currency is NOT the same as Parent's Presentation (reporting) Currency. The basis for using the temporal method is when Functional Currency = Parent's Presentation Currency. The temporal method is not required in the situation when the local currency is the functional currency. (Module 10.3, LOS 10.e) Question #75 of 82 Question ID: 1472566 Which of the following asset or liability values is likely to be the most understated in a hyperinflationary economy if translation occurs under the current rate method? A) A plant purchased several years ago. B) Dividends payable. C) Accounts receivable. Explanation The accounts receivable and dividends payable will each have book values that are closer to their market values than a plant purchased many years ago. (Module 10.7, LOS 10.g) Question #76 of 82 Question ID: 1472542 The Herlitzka Company, a U.S. multinational firm, has a 100 percent stake in a Swiss subsidiary. The U.S. dollar (USD) has been determined to be the functional currency. All the common stock of the subsidiary was issued at the beginning of the year and the subsidiary uses the weighted-average inventory cost-flow assumption. In addition, the value of the SF is as follows: Beginning of year $0.5902 Average throughout the year $0.6002 End of year $0.6150 The SF-based balance sheet and income statement data for the Swiss subsidiary are as follows: Accounts receivable = 3,000 Inventory = 4,000 Fixed assets = 12,000 Accounts payable = 2,000 Long-term debt = 5,000 Common stock = 10,000 Retained earnings = 2,000 Net income = 2,000 The remeasured value of accounts receivable and inventory respectively are closest to: A) $1,845 and $2,401. B) $1,845 and $2,361. C) $1,771 and $2,361. Explanation The basis for using the current rate method is when Functional Currency is NOT the same as Parent's Presentation (reporting) Currency. The basis for using the temporal method is when Functional Currency = Parent's Presentation Currency. Since the USD is the functional currency, use the temporal method. Under the temporal method, inventory is remeasured using the historical rate. However, our best guess of the historical rate under the weighted average inventory cost-flow assumption is the average rate through the period. Hence, A/R = $0.615 × 3,000 = $1,845 and Inventory = $0.6002 × 4,000 = $2,401. (Module 10.6, LOS 10.f) Della Air Lines has recently acquired Australian Puddle Jumpers, Inc. (APJ), a small airline located in Sydney. The Australian dollar has been chosen by Della as the functional currency for APJ. The balance sheet of APJ is given below as of Dec. 31, 2011 in U.S. dollars. Assets Cash Liabilities and Equity $100 Accounts Payable (A/P) Accounts Receivable (A/R) Maintenance Supplies Fixed Assets $90 120 Common Stock 360 90 140 Total Assets $450 Total Liabilities & Equity $450 APJ's income statement for the year ending Dec. 31, 2012 is expressed in Australian dollars as: Sales 3,500 Total Costs 2,900 Net Income 600 The Australian dollar has steadily depreciated against the U.S. dollar. At Dec. 31, 2011, the exchange rate was A$/US$ 2.50, the average rate during the year was A$/US$ 2.75 and A$/US$ 3.0 on Dec. 31, 2012. The Dec. 31, 2012 Balance Sheet for APJ is given in Australian dollars as follows: Assets Liabilities and Equity Cash 441 A/P 210 A/R 330 Common Stock 720 Supplies 291 Retained Earnings 600 Fixed Assets 468 Total Assets Question #77 - 80 of 82 1,530 Total Liabilities & Equity 1,530 Question ID: 1472512 On APJ's 2012 income statement, the level of sales in U.S. dollars would be closest to: A) $1,985. B) $1,272. C) $1,377. Explanation The basis for using the current rate method is when Functional Currency is NOT the same as Parent's Presentation (reporting) Currency. The basis for using the temporal method is when Functional Currency = Parent's Presentation Currency. Since the Australian dollar is the functional currency, use the current rate method. The items in the income statement are translated at the average exchange rate. The average rate is (2.5 + 3) / 2 = 2.75 Australian dollars per = US$. Income Statement (in $) Sales (3,500 / 2.75) $1,272 Costs (2,900 / 2.75) $1,055 Net Income $217 (Module 10.4, LOS 10.d) Question #78 - 80 of 82 Question ID: 1472513 On APJ's 2012 balance sheet, the level of accounts receivable is U.S. dollars would be closest to: A) $110. B) $132. C) $330. Explanation Since we are using the current rate method, all balance sheet accounts are translated at the current exchange rate, except for the common stock account, which is translated at the historical rate. A/R: (330 / 3) = 110 (Module 10.4, LOS 10.d) Question #79 - 80 of 82 Question ID: 1472514 For APJ, the conversion to US$ is most likely to result in: A) remeasurement gain. B) cumulative translation adjustment loss. C) cumulative translation adjustment gain. Explanation APJ shows a net asset: Total assets A$1,530 / (3.00 A$/US$) = US$510 Total liabilities A$210 / (3.00 A$/US$) = US$70 Net asset = US$440 Because the functional currency is the local currency, the current rate method is used. When we have a net asset balance sheet exposure, a weakening foreign currency will result in a negative translation adjustment. AJP's net asset position will result in a cumulative transaction adjustment loss as the foreign currency, the A$, is depreciating. Exposure Current rate method: Foreign Currency Appreciating Depreciating Net assets Gain Loss Net liabilities Loss Gain (Module 10.4, LOS 10.d) Question #80 - 80 of 82 Question ID: 1472515 If the functional currency is the reporting currency, the exposure and the foreign currency movements are most likely to result in a: A) remeasurement loss. B) cumulative translation adjustment loss. C) remeasurement gain. Explanation APJ has a net monetary asset exposure: Total monetary assets: Cash + A/R A$771 / (3.00 A$/US$) = US$257 Total monetary liabilities: A$210 / (3.00 A$/US$) = US$70 Net monetary asset = US$187 Because the functional currency is the reporting currency, the temporal method is used and this means there is remeasurement – a loss as the foreign currency, the A$, is depreciating. Exposure Temporal method: Foreign Currency Appreciating Depreciating Net monetary assets Gain Loss Net monetary liabilities Loss Gain (Module 10.4, LOS 10.d) Question #81 of 82 Question ID: 1472505 Which of the following general statements is CORRECT with respect to the temporal method? Revenues and operating expenses (excluding COGS) are translated at the: A) current rate. B) historical rate. C) average rate. Explanation As a general rule for the temporal method, all revenues and operating expenses (excluding COGS) are translated using the average rate. (Module 10.3, LOS 10.e) Question #82 of 82 Question ID: 1472533 An important distinction between the temporal method and the current rate method is that: depreciation and cost of goods sold (COGS) are a function of the current rate A) under translation (current rate method), but a function of the average rate under remeasurement (temporal method). the current rate method results in an adjustment to the equity account on the B) balance sheet. The temporal method results in a gain or loss appearing on the income statement. C) monetary assets and liabilities are remeasured (temporal method) at historical rates but translated (current rate method) at current rates. Explanation The current rate method results in an adjustment to the equity account on the balance sheet. The temporal method results in a gain or loss appearing on the income statement. Depreciation and COGS are a function of the average rate under the current rate method, but a function of the historical rate under the temporal method. Monetary assets and liabilities are use the current rates under both methods. (Module 10.4, LOS 10.e)