Which of the following measures is unaffected by the choice between translation under the all-current method and remeasurement under the temporal method?
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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.
Giant 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.
Exchange Rates were:
January 1, 2000
$0.14/M peso
January 1, 2001
$0.12/M peso
June 30, 2001
$0.11/M peso (this is the 2001 average rate)
December 31, 2001
$0.10/M peso
Grande, Inc.
Balance Sheet (in M Pesos)
Jan. 1, 2001
Dec. 31, 2001
Cash
5,000,000
20,000,000
Accounts Receivable
20,000,000
35,000,000
Inventory
15,000,000
15,000,000
Fixed Assets (net)
70,000,000
60,000,000
Accounts Payable
10,000,000
10,000,000
Long Term Debt
40,000,000
35,000,000
Common Stock
80,000,000
80,000,000
Retained Earnings
5,000,000
2001 Income Statement
(in M Pesos)
Sales
60,000,000
Cost of Goods Sold
(45,000,000)
Depreciation
(10,000,000)
Net Income
5,000,000
Giant Company should use the following method to reflect the results of Grande, Inc., in its financial statements:
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The basis for using the all current 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 used when the functional currency is the parent’s currency. (Study Session 6, LOS 24.c)
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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. (Study Session 6, LOS 24.c)
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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 (Study Session 6, LOS 24.d)
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Under the temporal method, translation gains and losses are included in the income statement. (Study Session 6, LOS 24.d)
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Under the temporal method, revenues are translated at the average rate during the reporting period. 60,000,000 × 0.11 = $6,600,000 (Study Session 6, LOS 24.d)
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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. (Study Session 6, LOS 24.d)
Dell Air Lines has recently acquired Australian Puddle Jumpers, Inc. (APJ), a small airline located in Sydney . The Australian dollar has been chosen by Dell as the functional currency for APJ. The Balance Sheet of APJ is given below as of
Assets
Liabilities and Equity
Cash
$100
Accounts Payable (A/P)
$90
Accounts Receivable (A/R)
120
Common Stock
360
Maintenance Supplies
90
Fixed Assets
140
Total Assets
$450
Total Liabilities & Equity
$450
APJ's income statement for the year ending
Sales
3,500
Total Costs
2,900
Net Income
600
The Australian dollar has steadily depreciated against the U.S. dollar. At
The Dec. 31, 2002 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
1,530
Total Liabilities & Equity
1,530
On APJ's 2002 income statement, the level of sales in U.S. dollars would be:
The basis for using the all current 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. Income Statement (in $) Sales (3,500 / 2.75) $1,272 Costs (2,900 / 2.75) $1,055
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 under FASB 52. The average rate is (2.5 + 3) / 2 = 2.75 Australian dollars = $1. Income Statement (in $) Sales (3,500 / 2.75) $1,272 Costs (2,900 / 2.75) $1,055
Since the Australian dollar is the functional currency, use the current rate method. In the balance sheet, all accounts are translated at the current exchange rate, except for the common stock account, which is translated at the historical rate.
$1,985.
$1,272.
$1,167.
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 under FASB 52. The average rate is (2.5 + 3) / 2 = 2.75 Australian dollars = $1.
Net Income
$217
On APJ's 2002 income statement, the level of net income in U.S. dollars would be:
$242.
$200.
$217.
Net Income
$217
On APJ's 2002 balance sheet, the level of accounts receivable is U.S. dollars would be:
$110.
$330.
$132.
A/R (330 / 3) = 110
Dell Air Lines has recently acquired Australian Puddle Jumpers, Inc., a small airline located in Sydney. The Australian dollar has been chosen by Dell as the functional currency for APJ. The Balance Sheet of APJ is given below as of Dec. 31, 2004 in Australian dollars.
Assets
Liabilities and Equity
Cash
200
A/P
180
A/R
240
Common Stock
720
Maintenance Supplies
180
Fixed Assets
280
Total Assets
900
Total Liab & Equity
900
APJ's income statement for the year ending Dec. 31, 2005 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, 2004, the exchange rate was 2 Australian dollars = $1 but at Dec. 31, 2005, the exchange rate had deteriorated to 3 Australian dollars = $1.
The Dec. 31, 2005 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
1,530
Total Liab. & Equity
1,530
On APJ's 2005 income statement, the level of net income in U.S. dollars would be:
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The basis for using the all current 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 both the local and 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 + 3) / 2 = 2.5 Australian dollars = $1. (Study Session 6, LOS 24.d)
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Since the Australian dollar is the local and the functional currency, use the current rate method. In the balance sheet, all accounts are translated at the current exchange rate, except for the common stock account, which is translated at the historical rate. Common Stock (720 / 2) = 360 (Study Session 6, LOS 24.d)
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Since there is no mention of dividends being paid, the retained earnings will equal net income (RE = NI ? Div). The items in the income statement are translated at the average exchange rate under SFAS 52. The average rate is (2 + 3) / 2 = 2.5 Australian dollars = $1.
Income Statement (in $) (Study Session 6, LOS 24.d)
Sales (3,500 / 2.5)
$1,400
Costs (2,900 / 2.5)
$1,160
Net Income
$240
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Since the Australian dollar is both the local and the functional currency, use the current rate method. When using the current rate method, all assets and liabilities are translated at the current rate. Total assets = 1530/3 = 510 and accounts payable = 210/3 = 70. The common stock is translated at the historical rate on the date of purchase = 720/2 = 360. Beginning retained earnings = 0, so ending retained earnings = translated net income = 240. The cumulative translation adjustment is the plug figure that makes the balance sheet balance = 510 ? 70 ? 360 ? 240 = -160. (Study Session 6, LOS 24.d)
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The conditions necessary for implementation of the temporal method are: (Study Session 6, LOS 24.c)
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If the U.S. dollar had been chosen as the functional currency, then the provisions of the temporal method would apply. Under the temporal method, the translation adjustment would appear as a line item on Dell's income statement and not as an element of equity. Hence, earnings may become more volatile as a result. (Study Session 6, LOS 24.c)
The Precision Screen Printers (PSP) Company has a foreign subsidiary, the Acer Tool & Die Company, located in the country of Rolivia. The currency of Rolivia is the Chad. The balance sheet and income statement of Acer Tool & Die Company for the year-ended December 31, 2005, is shown below. The balance sheet has been restated using the U.S. dollar as the functional currency.
Acer Tool & Die Company Balance Sheet
As of December 31, 2005Chad
(millions)
Exchange Rate
(Chad/US$)
U.S. $
(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 $2,020 Accounts payable 50 0.25 $200 Capital stock 380 0.3333 1,140 Retained earnings 220 -- 680 Total liabilities and equity 650 $2,020
Acer Tool & Die Company Income Statement
For year ending December 31, 2005
(Amounts in millions of Chad)Revenues 1,000 Cost of sales 700 Depreciation expense 50 Selling expense 30 Translation gain (or loss) Net income 220
Acer has determined that the exchange rate exposure at the beginning of 2005 is ?260 Chad.
The exchange rate at the beginning of 2005 was 0.3333 Chad/US$. The exchange rate at the end of 2005 was 0.25 Chad/US$. The average rate for 2005 is 0.3125 Chad/US$. Beginning inventory is 90 Chad. 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.
What is Acer Tool & Die's cost of sales in U.S. dollars using the temporal method?
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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 $2,222
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Remeasured income statement under temporal method: Revenues = 1000/0.3125 = 3200 COGS = 2222 (from previous question) Depreciation = 50/0.3333 = 150 Selling expense = 30/0.3125 = 96 Income before remeasurement gain = 3200 ? 2222 ? 150 ? 96 = 732 Net income = 680 (= retained earnings at year end 2005 ? retained earnings at year end 2004) Remeasurement gain/loss = 680 ? 732 = -52
Wasson Brothers (WB) is a large U.S. based conglomerate with many subsidiaries in both the U.S. and abroad. One of WB's wholly-owned foreign subsidiaries, Kasamatsu Industries, is based in Japan and manufactures a hugely successful line of trading cards, toys, and other related products. All of Kasamatsu's operations and sales take place in Japan, and the corresponding transactions are denominated in Japanese yen. Additionally, Kasamatsu's books and records are all maintained in yen. WB reports its earnings in U.S. dollars. The history of the exchange rate between the dollar and the yen over the last two years is presented in the following table. Figures are presented in /$.
Yen/Dollar Exchange Rate
December 31, 2002 150 December 31, 2001 130 2002 Average 140 2001 Average 120 Exchange rate on date that 2002 dividends were paid to Wasson Brothers 145 Exchange rate on date of stock issue and acquisition of fixed assets. 100
If Jameson wishes to convert any of the figures on Kasamatsu's Income Statement from yen to dollars, she should use which of the following exchange rates (/$)?
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Ideally, all of the components on the income statement would be translated at the exchange rate that was in effect on the day that the transactions took place. For example, all sales that occurred on March 15, 2002, would be translated at the exchange rate that prevailed on that date. Likewise, if a large portion of inventory was purchased on October 27, 2002, then the appropriate portion of cost of goods sold would be calculated using the exchange rate from October 27, 2002. This however, is not especially practical, especially for a very large company with many transactions. The common practice is to use the average exchange rate for the accounting year, in this case 140 JPY/USD.
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Because an asset is, in effect, being transferred from the balance sheet of the subsidiary to that of the parent (in this case the asset is cash in the form of a dividend) on a known date, it is appropriate to use the exchange rate that prevails on the dividend date.
Wasson Brothers (WB) is a large U.S. based conglomerate with many subsidiaries in both the U.S. and abroad. One of WB's wholly-owned foreign subsidiaries, Kasamatsu Industries, is based in Japan and manufactures a hugely successful line of trading cards, toys, and other related products. All of Kasamatsu's operations and sales take place in Japan, and the corresponding transactions are denominated in Japanese yen. Additionally, Kasamatsu's books and records are all maintained in yen. WB reports its earnings in U.S. dollars. The history of the exchange rate between the dollar and the yen over the last two years is presented in the following table. Figures are presented in yen/$.
Yen/Dollar Exchange Rate
December 31, 2002 150 December 31, 2001 130 2002 Average 140 2001 Average 120 Exchange rate on date that 2002 dividends were paid to Wasson Brothers 145 Exchange rate on date of stock issue and acquisition of fixed assets. 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, 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, 2002
(in thousands on 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, 2001 250,000 369,000 Dividends 58,000 Retained Earnings: December 31, 2002 * 311,000 * Retained earnings on 12/31/2002 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 stockholder's equity Liabilities 300,000 Capital stock 175,000 Retained earnings 311,000 Total liabilities and stockholder's equity 786,000
Jameson has finally completed translating all the necessary figures into dollars and now wants to compute how much WB's reported sales in dollars will change due to Kasamatsu's sales. Which of the following is closest to Jameson's answer (in thousands of dollars)?
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The basis for using the all current 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. 700,000 140 WB will report $5,000 of sales as a result of Kasamatsu's operations. Both remaining answers use incorrect exchange rates.
Because sales is an income statement item, the 2002 average exchange rate of 140, JPY/USD must be used to calculate sales in the reporting currency. Kasamatsu's sales were JPY 700,000. The calculation is:
= 5,000
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Total selling expenses include cost of goods sold, depreciation, and SG&A. Kasamatsu reported a total of JP 483,000. Since these are all income statement items they must all be translated at the average 2002 exchange rate of 140 JP/US$. Therefore, the calculation is: 483,000 140 Both remaining answers use incorrect exchange rates.
= 3,450
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:
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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.
Dell Air Lines has recently acquired Australian Puddle Jumpers, Inc., a small airline located in Sydney. The Australian dollar has been chosen by Dell as the functional currency for APJ. The Balance Sheet of APJ is given below as of
Assets
Liabilities and Equity
Cash
$200
A/P
$180
A/R
240
Common Stock
720
Maintenance Supplies
180
Fixed Assets
280
Total Assets
$900
Total Liab & Equity
$900
APJ's income statement for the year ending
Sales
3,500
Total Costs
2,900
Net Income
600
The Australian dollar has steadily depreciated against the U.S. dollar. At
The Dec. 31, 2005 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
1,530
Total Liab. & Equity
1,530
On APJ's 2005 income statement, the level of sales in U.S. dollars would be:
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Since the Australian $ is both the local and the functional currency, use the current rate method. The items in the income statement are translated at the average exchange rate under FASB 52. The average rate is (2 + 3) / 2 = 2.5 Australian dollars = $1.
Income Statement (in $)
Sales (3,500 / 2.5)
$1,400
Costs (2,900 / 2.5)
$1,160
Net Income
$240
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Since the Australian $ is both the local and the functional currency, use the current rate method.
In the balance sheet, all 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
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Since the Australian $ is both the local and the functional currency, use the current rate method. In the balance sheet, all accounts are translated at the current exchange rate, except for the common stock account, which is translated at the historical rate.
Fixed Assets (468 / 3) = 156
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/$.
Yen/Dollar Exchange Rate
December 31, 2002 150 December 31, 2001 130 2002 Average 140 2001 Average 120 Exchange rate on date that 2002 dividends were paid to Wasson Brothers 145 Exchange rate on date of stock issue and acquisition of fixed assets. 100
Jameson would like to look at some of Kasamatsu's figures in U.S. dollars. However, she must use the appropriate rate to convert the numbers from yen into dollars. What is the appropriate exchange rate (yen/$) to use in converting Kasamatsu's assets?
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Because the current method of currency translation is being used all assets and liabilities are translated using the exchange rate in effect on the balance sheet date. In this particular case, the exchange rate prevailing on December 31, 2002, is the appropriate rate.
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Under the current method, assets and liabilities are translated at the exchange rate prevailing on the balance sheet date.
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Because WB issued stock and acquired Kasamatsu and their capital stock, they must carry that capital stock on their balance sheet at historical cost, which will be the basis for calculating depreciation expense. Therefore, even though this is a balance sheet item, the exchange rate that prevailed on the date of the acquisition of the capital stock must be used to translate into the reporting currency. Using the exchange rate that was effective on the balance sheet date would be improper, as this would cause the "historical" cost of the capital stock to fluctuate.
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, 2002, 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, 2002
Chad
(millions)
Exchange Rate
(Chad/US$)
U.S. $
(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 $2,020 Accounts payable 50 0.25 $200 Capital stock 380 0.3333 1,140 Retained earnings 220 -- 680 Total liabilities and equity 650 $2,020
Acer Tool & Die Company Income Statement
For year ending December 31, 2002
(Amounts in millions of Chad)
Revenues 1,000 Cost of sales 700 Depreciation expense 50 Selling expense 30 Net income 220
The exchange rate at the beginning of 2002 was 0.3333 Chad/US$. The exchange rate at the end of 2002 was 0.25 Chad/US$. The average rate for 2002 is 0.3125 Chad/US$. Beginning inventory is 90 Chad. Acer Tool & Die uses FIFO inventory valuation and depreciates fixed assets using the straight-line method.
Using the current rate method for the Acer Tool & Die Company, what is the value of total assets after translation?
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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.
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 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:
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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.
Which of the following statements concerning the translation of a subsidiary’s financial statement and the subsidiary’s ratios is FALSE?
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Ratios calculated under the all-current method will differ from those calculated under the temporal method.
Which of the following subsidiary ratios will be affected by the translation adjustment under the all-current method?
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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.
Which of the following statements most accurately describes a financial effect of translation?
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Profit margins may be distorted, especially if FIFO inventory accounting is used.
Which example least accurately describes pure balance sheet and income statement ratios?
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All pure balance sheet ratios are unaffected by the all-current translation method.
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:
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The basis for using the all current 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.
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:
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The basis for using the all current 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.
The U.S. dollar has been appreciating relative to the local currency over the past year. Using 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 long-term debt to equity ratio (LTD/E) relative to what the ratio would have been without the effects of translation?
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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.
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?
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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.
The 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?
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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.
Which of the following ratios is unaffected by the choice between translation under the all-current method and remeasurement under the temporal method?
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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.
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 return on equity (ROE) relative to what the ratio would have been without the effects of translation?
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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.
As Heltzel is translating the balance sheet and income statement, which of the following are closest to the values Heltzel determines for revenues and accounts payable for 2008?
| Revenues | Accounts Payable |
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Since the British pound is the functional currency, the temporal method should be used. Under both the all-current and temporal methods, revenues are translated at the average rate. The value Heltzel will calculate for revenues is $75,000 / $1.70 = ￡44,118. Also, under both the temporal and all-current methods, monetary assets and liabilities are calculated using the current exchange rate. The value Heltzel will calculate for accounts payable will be $6,000 / $1.80 = ￡3,333. (Study Session 6, LOS 24.d)
Suppose that after remeasurement, Wilson’s 2008 year end total assets are ￡31,212, and total liabilities are ￡17,222. The remeasured retained earnings at year end 2008 will be closest to:
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Under the temporal method, the retained earnings will be derived as a plug figure that makes the balance sheet balance. The common stock value on the remeasured balance sheet will be $10,000/1.5 = ￡6,667. Total assets ? total liabilities ? common stock = retained earnings. 31,212 ? 17,222 ? 6,667 = ￡7,323. (Study Session 6, LOS 24.d)
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Net income = ending retained earnings ? beginning retained earnings + dividends paid. Net income = 7323 ? 5150 + 2250 = ￡4423. Remeasurement gain = net income ? net income before remeasurement gain = 4423 ? 4138 = ￡285. (Study Session 6, LOS 24.d)
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Quick Ratio |
Accounts Receivable Turnover |
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The quick ratio takes (cash + accounts receivable) / (current liabilities). Since all of these items are monetary assets and liabilities, they are all remeasured at the current exchange rate, resulting in no change to the ratio. The accounts receivable turnover ratio is calculated as (sales / accounts receivable). Note that the local currency (the U.S. dollar) is depreciating (it takes more $ to buy a pound). Since sales is remeasured at the average rate and accounts receivable is remeasured at the current rate, the depreciating currency means that the remeasured denominator will be smaller than the remeasured numerator, resulting in a larger ratio. (Study Session 6, LOS 24.d)
Heltzel decides to redefine the functional currency to assess how the all-current vs. the temporal method will impact Wilson’s financial statements. Wilson’s gross profit margin will be lower under the:
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Wilson’s gross profit margin (gross profit / sales) will be lower under the temporal method. Sales under both methods are converted at the average rate, while COGS is converted at the historical rate under the temporal method (note FIFO inventory accounting). Since the local currency (the U.S. dollar) is depreciating, COGS will be higher under temporal method, resulting in a lower gross profit and a lower gross profit margin. Wilson’s total asset turnover ratio (sales / total assets) will be higher under the all-current method. Non-monetary assets are converted at the historical rate using the temporal method and the current rate under the all-current method. The depreciating local currency means that total assets will be lower under the all-current method. The lower denominator will lead to a higher total asset turnover ratio under the all-current method. (Study Session 6, LOS 24.d)
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:
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The basis for using the all current 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.
Which of the following statements is most accurate concerning foreign currency translation?
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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 inventory is bought and sold evenly throughout the year and thus the appropriate historical rate to use for cost of goods sold (COGS) is the average rate which is also the rate used for COGS with the current rate 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.
Which of the following ratios is affected by translation under the all-current method?
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Recall that all pure income statements and balance sheet ratios are unaffected by translation under the all-current 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).
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The net profit margin is a pure income statement ratio, meaning it will be unaffected by the application of the all-current method. The calculation is shown below:
Under the all current method, all income statement accounts will be translated at the average rate. Revenue 7,400,000 $0.37 $2,738,000 Cost of Goods Sold (COGS) (5,200,000) $0.37 (1,924,000) Depreciation (1,200,000) $0.37 (444,000) Taxes (250,000) $0.37 (92,500) Net Income 750,000 $0.37 $277,500 Note that under the all-current method, since all income statement accounts are translated at the same average rate, you do not have to translate the income statement to get the correct answer. (750,000 / 7,400,000) = 10.1%. (Study Session 6, LOS 24.d)
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The receivables turnover ratio is calculated as (sales / receivables). Under the both the all-current and temporal methods, sales are translated at the average rate, while receivables are translated at the current rate. Since both the sales and receivables components are translated at the same rate, there will be no difference in the ratios between the two methods. (Study Session 6, LOS 24.d)
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The total asset turnover ratio = (sales / total assets)
We can see from the exchange rates that the Russian ruble is depreciating (it takes fewer dollars to buy a ruble). With a depreciating local currency, sales are going to be the same under either method, since sales are translated at the average rate. Assets on the other hand will be higher under the temporal method, and lower under the all-current method. This is because all assets are translated at the current rate under the all-current method (which has the lower exchange rate), and at different rates under the temporal method (which is has fixed assets converted at the higher historical rate). With the same numerator and lower denominator, the all-current method will lead to the higher total asset turnover ratio. (Study Session 6, LOS 24.d)
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Since it is taking fewer dollars to buy a ruble, the exchange rate is depreciating. Both the debt-to-equity and debt-to-capital ratios will be lower under the temporal method versus the all-current method if a foreign currency is depreciating. Under both methods, long term debt and accounts payable are both translated at the current exchange rate, so those are the same. Equity under the temporal method is effectively translated at a mixed rate under the temporal method, and the current rate under the all-current method. Since the currency is depreciating, the equity value will be higher under the mixed rate scenario. With the same debt and higher equity, the temporal method will lead to a lower debt-to-equity ratio than the all-current method. Assets under the temporal method are also effectively translated at a mixed rate under the temporal method, and the current rate under the all-current method. Since the currency is depreciating, the asset value will be higher under the mixed rate scenario. With the same debt and higher assets, the temporal method will lead to a lower debt-to-capital ratio than the all-current method. (Study Session 6, LOS 24.d)
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If the ruble was depreciating, Evert would report a higher gross profit margin under the all-current method. Under both the temporal and all-current methods, revenues are translated at an average rate, while COGS are translated at a historical rate under the temporal method and an average rate under the all-current method. A depreciating currency means that COGS would be higher under the temporal method, resulting in a lower gross profit margin. The other statements are true – an appreciating foreign currency tends to have the largest impact on the parent company’s financials and the statement of cash flows should theoretically be the same under both methods but flow effects from changing rates will have an impact on reporting currency methods. (Study Session 6, LOS 24.c)
Which of the following statements regarding the effects of translation on financial ratios is least accurate?
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Fixed assets are lower under the temporal method if the local currency appreciates.
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:
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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.
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:
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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.
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