40． 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 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.

What is Acer Tool & Die's cost of sales in U.S. dollars using the temporal method?

A)   $2,240.

B)   $2,242.

C)   $2,800.

D)   $2,222.

41．t is the translation gain or loss for the period using the temporal method?

A)   $52 loss.

B)   $50 gain.

C)   $32 loss.

D)   $50 loss.

42．l 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.

APJ's income statement for the year ending Dec. 31, 2005 is expressed in Australian dollars as:

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:

On APJ's 2005 income statement, the level of net income in U.S. dollars would be:

A)   $240.

B)   $200.

C)   $300.

D)   $600.

43．APJ's 2005 balance sheet, the level of common stock (not including retained earnings) in U.S. dollars would be:

A)   $288.

B)   $240.

C)   $196.

D)   $360.

44．APJ's 2005 balance sheet, the level of retained earnings in U.S. dollars would be:

A)   $240.

B)   $200.

C)   $300.

D)   $345.

45．APJ's 2005 balance sheet, the foreign currency translation adjustment in U.S. dollars would be:

A)   negative $220.

B)   negative $280.

C)   positive $160.

D)   negative $160.

46．ch one of the following is a condition under which the temporal method should be used to account for foreign currency translations?

A)   The cumulative Australian inflation rate over the last three years would have to be less than 100%.

B)   APJ would have to be a mere operational extension of Dell's main operations.

C)   If Dell desires a smoother earnings stream.

D)   The Australian dollar is chosen as the functional currency.

47．ch one of the following statements correctly describes the effect on Dell's financial statements if the U.S. dollar had been chosen as the functional currency?

A)   The current rate method would apply.

B)   Dell's reported earnings would probably become less volatile over time.

C)   The translation adjustment would appear as a line item on Dell's balance sheet.

D)   The translation adjustment would appear as a line item on Dell's income statement.

A)   $288.

B)   $240.

C)   $196.

D)   $360.

44．APJ's 2005 balance sheet, the level of retained earnings in U.S. dollars would be:

A)   $240.

B)   $200.

C)   $300.

D)   $345.

45．APJ's 2005 balance sheet, the foreign currency translation adjustment in U.S. dollars would be:

A)   negative $220.

B)   negative $280.

C)   positive $160.

D)   negative $160.

46．ch one of the following is a condition under which the temporal method should be used to account for foreign currency translations?

A)   The cumulative Australian inflation rate over the last three years would have to be less than 100%.

B)   APJ would have to be a mere operational extension of Dell's main operations.

C)   If Dell desires a smoother earnings stream.

D)   The Australian dollar is chosen as the functional currency.

47．ch one of the following statements correctly describes the effect on Dell's financial statements if the U.S. dollar had been chosen as the functional currency?

A)   The current rate method would apply.

B)   Dell's reported earnings would probably become less volatile over time.

C)   The translation adjustment would appear as a line item on Dell's balance sheet.

D)   The translation adjustment would appear as a line item on Dell's income statement.

What is Acer Tool & Die's cost of sales in U.S. dollars using the temporal method?

A)   $2,240.

B)   $2,242.

C)   $2,800.

D)   $2,222.

The correct answer was D)

Purchases = COGS - Beginning inventory + ending inventory = 710 Chad

41．t is the translation gain or loss for the period using the temporal method?

A)   $52 loss.

B)   $50 gain.

C)   $32 loss.

D)   $50 loss.

The correct answer was A)

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 = -260 Chad (this was given)

Ending exposure = (20 + 30) – (50 + 0 + 0) = 0

Change in exposure = (0 - (-260)) =  260

Flow effect (in $) = 260 × [(1/0.25) – (1/0.3125)] = 260 × [4 – 3.2] = 208

Holding gain/loss effect (in $) = -260 × [(1/0.25) – (1/0.3333)] = -260 × [4 – 3] = -260

Translation loss (in $) = flow effect + holding gain/loss effect = $208 + (-$260) = -$52

42．l 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.

APJ's income statement for the year ending Dec. 31, 2005 is expressed in Australian dollars as:

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:

On APJ's 2005 income statement, the level of net income in U.S. dollars would be:

A)   $240.

B)   $200.

C)   $300.

D)   $600.

The correct answer was A)

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

43．APJ's 2005 balance sheet, the level of common stock (not including retained earnings) in U.S. dollars would be:

A)   $288.

B)   $240.

C)   $196.

D)   $360.

The correct answer was D)

Since the Australian $ 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

44．APJ's 2005 balance sheet, the level of retained earnings in U.S. dollars would be:

A)   $240.

B)   $200.

C)   $300.

D)   $345.

The correct answer was A)

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 $)

45．APJ's 2005 balance sheet, the foreign currency translation adjustment in U.S. dollars would be:

A)   negative $220.

B)   negative $280.

C)   positive $160.

D)   negative $160.

The correct answer was D)

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, so the net exposure is assets minus liabilities, or total shareholder’s equity.

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 = 720

Ending exposure = (720 + 600) = 1320

Change in exposure = (1320 – 720) = 600

Flow effect (in $) = 600 × [(1/3) – (1/2.5)] = -$40

Holding gain/loss effect (in $) = 720 × [(1/3) – (1/2)] = -$120

Translation gain/loss (in $) = flow effect + holding gain/loss effect = -$40 + (-$120) = -$160

46．ch one of the following is a condition under which the temporal method should be used to account for foreign currency translations?

A)   The cumulative Australian inflation rate over the last three years would have to be less than 100%.

B)   APJ would have to be a mere operational extension of Dell's main operations.

C)   If Dell desires a smoother earnings stream.

D)   The Australian dollar is chosen as the functional currency.

The correct answer was B)

The conditions necessary for implementation of the temporal method are:

1.   APJ would have to be a mere operational extension of Dell's main operations. If the operations of the subsidiary are well integrated with the parent’s then the parent’s currency (in this case, the U.S. dollar) would be the functional currency.

2.   The cumulative Australian inflation rate over the last 3 years would have to exceed 100%. (Hyperinflation)

47．ch one of the following statements correctly describes the effect on Dell's financial statements if the U.S. dollar had been chosen as the functional currency?

A)   The current rate method would apply.

B)   Dell's reported earnings would probably become less volatile over time.

C)   The translation adjustment would appear as a line item on Dell's balance sheet.

D)   The translation adjustment would appear as a line item on Dell's income statement.

The correct answer was D)     

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.