19.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:

The SF-based balance sheet and income statement data for the Swiss subsidiary are as follows:

The translated value of accounts receivable and inventory respectively are:

A)   $1,845 and $2,460.

B)   $1,845 and $2,401.

C)   $1,801 and $2,401.

D)   $1,801 and $2,361.

20.Hise Home Supply is a large, profitable home improvement retailer located in the United Kingdom. Hise has recently been acquiring niche retailers with popular brand names in certain segments of the home improvement market. One of these retailers was Wilson Tile and Stone, a U.S. business that derived a large part of its sales from the UK. Wilson was acquired December 31, 2005 and the management team for Hise now makes all operating, financing, and investment decisions. Brian Heltzel, a financial analyst for Hise, has been tasked with translating Wilson’s 2005 and 2006 financial statements from U.S. dollars to the reporting currency. Hise conducts its business and issues financial statements in British pounds (£).

Wilson uses the FIFO method for inventory accounting.

Applicable exchange rates are as follows:

§ December 31, 2004: £1.00 = $1.60

§ December 31, 2005: £1.00 = $1.80

§ Average for 2005 = £1.00 = $1.70

§ Historical rate for fixed assets, inventory, and equity: £1.00 = $1.50

Which of the following statements regarding foreign currency translation methods is CORRECT?

A)   The British pound is the functional currency and Heltzel should use the temporal method.

B)   The British pound is the reporting currency and Heltzel should use the all-current method.

C)   The U.S. dollar is the functional currency and Heltzel should use the all-current method.

D)   The U.S. dollar is the functional currency and Heltzel should use the temporal method.

21.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 2005?

A)         £41,667                       £3,333

B)          £44,118                       £3,333

C)         £41,667                       £3,750

D)         £44,118                       £3,529

22.Using the appropriate translation method, what will be the translation gain or loss Heltzel will record, and which of the financial statements will he record it on?

A)         -$392.14                           Income statement

B)          +$1,518.72                       Income statement

C)         -$392.14                           Balance sheet

D)         +1,518.72                         Balance sheet

19.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:

The SF-based balance sheet and income statement data for the Swiss subsidiary are as follows:

The translated value of accounts receivable and inventory respectively are:

A)   $1,845 and $2,460.

B)   $1,845 and $2,401.

C)   $1,801 and $2,401.

D)   $1,801 and $2,361.

The correct answer was A)

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.

20.Hise Home Supply is a large, profitable home improvement retailer located in the United Kingdom. Hise has recently been acquiring niche retailers with popular brand names in certain segments of the home improvement market. One of these retailers was Wilson Tile and Stone, a U.S. business that derived a large part of its sales from the UK. Wilson was acquired December 31, 2005 and the management team for Hise now makes all operating, financing, and investment decisions. Brian Heltzel, a financial analyst for Hise, has been tasked with translating Wilson’s 2005 and 2006 financial statements from U.S. dollars to the reporting currency. Hise conducts its business and issues financial statements in British pounds (£).

Wilson uses the FIFO method for inventory accounting.

Applicable exchange rates are as follows:

§ December 31, 2004: £1.00 = $1.60

§ December 31, 2005: £1.00 = $1.80

§ Average for 2005 = £1.00 = $1.70

§ Historical rate for fixed assets, inventory, and equity: £1.00 = $1.50

Which of the following statements regarding foreign currency translation methods is CORRECT?

A)   The British pound is the functional currency and Heltzel should use the temporal method.

B)   The British pound is the reporting currency and Heltzel should use the all-current method.

C)   The U.S. dollar is the functional currency and Heltzel should use the all-current method.

D)   The U.S. dollar is the functional currency and Heltzel should use the temporal method.

The correct answer was A)

Subsidiaries whose operations are well integrated with the parent (i.e. parent makes operating, financing, and investing decisions) will use the parent’s currency as the functional currency. In this case, the British pound is both the functional and the reporting currency. Since Heltzel is translating from the local to the functional currency, remeasurement under the temporal method is appropriate.

21.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 2005?

A)         £41,667                       £3,333

B)          £44,118                       £3,333

C)         £41,667                       £3,750

D)         £44,118                       £3,529

The correct answer was B)

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.

22.Using the appropriate translation method, what will be the translation gain or loss Heltzel will record, and which of the financial statements will he record it on?

A)         -$392.14                           Income statement

B)          +$1,518.72                       Income statement

C)         -$392.14                           Balance sheet

D)         +1,518.72                         Balance sheet

The correct answer was B)

Since the British pound is the functional currency, the temporal method should be used. Under the temporal method, the translation gain/loss is reported on the income statement.

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 = (1,200 + 6,500) – (5,000 + 1,500 + 25,000) = -23,800

Ending exposure = (1,400 + 9,900) – (6,000 + 1,500 + 23,500) = -19,700

Change in exposure = -19,700 – (-23,800) = 4,100

Flow effect (in $) = 4,100 × [(1/1.80) – (1/1.70)] = 4,100 × [0.5556 – 0.5882] = -133.60

Holding gain/loss effect (in $) = -23,800 × [(1/1.80) – (1/1.60)] = -23,800 × [0.5556 – 0.6250] = 1,651.72

Translation loss (in $) = flow effect + holding gain/loss effect = -133.60 + 1,651.72 = $1,518.12.