Reading 26- LOS f ～ Q55－59

55.nt Company is a U.S. firm that produces parts for nuclear reactors. Giant Company has a subsidiary, Grande, Inc., that operates in Mexico and is responsible for designing and manufacturing connection fittings that are vital for the proper operation of its parent company’s reactors.

§ Giant Company considers the U.S. dollar to be the functional currency of Grande, Inc.

§ Grande, Inc., began operations January 1, 2001.

§ Common Stock and Fixed Assets were acquired January 1, 2000.

§ Inventory is accounted for under the last in, first out (LIFO) cost flow assumption, with a slow rate of turnover.

§ The inventory in the January 1, 2001, Balance Sheet was acquired on January 1, 2001.

Giant Company should use the following method to reflect the results of Grande, Inc., in its financial statements:

A)   the all-current method.

B)   the temporal method followed by the all-current method.

C)   the temporal method.

D)   the all-current method followed by the temporal method.

The correct answer was C)

The temporal method is used when the functional currency is the parent’s currency

56. Cost of Goods Sold for Grande, Inc., for the year ended December 31, 2001, expressed in U.S. dollars is:

A)   $4,950,000.

B)   $5,400,000.

C)   $4,650,000.

D)   $5,250,000.

The correct answer was A)

Both the beginning and ending inventory under LIFO cost flow assumptions and a slow inventory turnover are translated at the $0.12 rate as of the date the original inventory was acquired, January 1, 2001. Because beginning and ending inventories expressed in Mexican pesos are equal, the purchases for the year will equal the Cost of Goods Sold, which is remeasured at the average cost of acquiring the goods during the year: $0.11. (45,000,000 * $0.11) = $4,950,000.

56.t is the translation gain or loss for Grande, Inc., for the year ended December 31, 2001?

A)   $200,000.

B)   -$600,000.

C)   $150,000.

D)   $900,000.

The correct answer was C)

When using the temporal method, only cash, accounts receivable, accounts payable, current debt, and long-term debt are translated at the current rate. This means that exposure under the temporal method is:

(cash + accounts receivable) – (accounts payable + current debt + long-term debt)

The currency translation adjustment (CTA) is calculated as the sum of the flow effect and holding effect.

Flow effect (in $) = change in exposure (in LC) × (ending rate – average rate)

Holding gain/loss effect (in $) = beginning exposure (in LC) × (ending rate – beginning rate)

Going back to our data in the example:

Beginning exposure = (5,000,000 + 20,00,000) – (10,000,000 + 0 + 40,000,000) = -25,000,000

Ending exposure = (20,000,000 + 35,000,000) – (10,000,000 + 0 + 35,000,000) = 10,00,000

Change in exposure = 10,000,000 – (-25,000,000) = 35,000,000

Flow effect (in $) = 35,000,000 × [$0.10 – $0.11] = 35,000,000 × [– $0.01] = -$350,000

Holding gain/loss effect (in $) = -25,000,000 × [$0.10 – $0.12] = -25,000,000 × [-$0.02] = $500,000

Translation gain (in $) = flow effect + holding gain/loss effect = -$350,000 + $500,000 = $150,000

57. translation gain or loss from the activities of Grande, Inc., should be reported in:

A)   the income statement.

B)   the statement of cash flows.

C)   net fixed assets.

D)   the statement of shareholder’s equity.

The correct answer was A)     

Under the temporal method, translation gains and losses are included in the income statement.

58.enues for 2001 translated into U.S. dollars amount to:

A)   $7,800,000.

B)   $6,600,000.

C)   $6,000,000.

D)   $8,400,000.

The correct answer was B)

Under the temporal method, revenues are translated at the average rate during the reporting period.

60,000,000 * 0.11 = $6,600,000

59.a result of making the appropriate currency adjustments to the financial statements, Grande Inc.’s December 31, 2001 quick ratio will be:

A)   higher, and the current ratio will be higher.

B)   lower, and the current ratio will be higher.

C)   unchanged, and the current ratio will be unchanged.

D)   unchanged, and the current ratio will be higher.

The correct answer was D)

Since the functional currency is the reporting currency, the temporal method must be used. Since it is taking fewer dollars to buy a peso, the peso is depreciating.

The quick ratio is a liquidity ratio that does not include inventory. The quick ratio is calculated as [(cash + accounts receivable) / accounts payable]. Since monetary assets and liabilities are translated at the current rate, the quick ratio will be unchanged. The current ratio however is calculated as [(cash + accounts receivable + inventory) / accounts payable]. Since inventory is accounted for under LIFO, inventory is translated at the historical rate while the other components of the ratio are translated at the current rate. Using the historical rate for inventory will lead to a higher numerator and a higher current ratio.