Reading 26- LOS g ～ Q 1－5

1．e 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)   The ratio will rise.

B)   The ratio will fall.

C)   There will be no affect on the ratio.

D)   The affect on the ratio is indeterminate.

The correct answer was C)

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.

2．e U.S. dollar has been appreciating relative to the local currency 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 fall.

B)   The ratio will rise.

C)   The effect on the ratio is indeterminate.

D)   There will be no effect on the ratio.

The correct answer was A)

Since the dollar is appreciating the local currency is depreciating thus each foreign currency unit is buying 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 falling.

3．ich of the following ratios is unaffected by the choice between translation under the all-current method and remeasurement under the temporal method?

A)   Quick ratio.

B)   Inventory turnover.

C)   Accounts payable turnover.

D)   Current ratio.

The correct answer was A)

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 all-current method.

4．e 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 Return On Equity (ROE) 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)   ROE will remain unchanged.

D)   The impact of the depreciation of the US dollar on ROE is indeterminate.

The correct answer was B)

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 entire ratio falls.

5．ich of the following measures is unaffected by the choice between translation under the all-current method and remeasurement under the temporal method?

A)   Tax expense.

B)   Cost of goods sold.

C)   Depreciation.

D)   Equity.

The correct answer was A)

Taxes are converted at the same rate (average rate) under both methods. Equity under the temporal method is a mixed rate whereas under the all-current method it is at the current rate.  COGS under the temporal method is at the historical rate and under the all-current method it is at the average rate. Depreciation is at the historical rate with the temporal method whereas under the all-current method it is translated at the average rate.