土豆妮

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?

A) There will be no effect on the ratio.

B) The ratio will rise.

C) The ratio will fall.

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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.

土豆妮

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

A) Accounts payable turnover.

B) Current ratio.

C) Quick ratio.

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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.

 

土豆妮

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?

A) ROE will most likely decline.

B) ROE will most likely rise.

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

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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.

土豆妮

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

A) ￡44,118 ￡3,333

B) ￡44,118 ￡3,529

C) ￡41,667 ￡3,333

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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)

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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:

A) ￡7,323.

B) ￡4,278.

C) ￡5,133.

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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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Suppose that 2008 income before remeasurement gain/loss is ￡4,138. Dividends paid during the year are ￡2,250, and beginning retained earnings are ￡5,150. Assume for purposes of this question only the ending retained earnings are 7,323. The remeasurement gain/loss for 2008 will be closest to:

A) -￡77.

B) ￡1,012.

C) ￡285.

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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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After remeasurement, what will be the impact on Wilson’s quick ratio and accounts receivable turnover ratios respectively for 2008?

Quick Ratio

Accounts Receivable Turnover

A) Increase Increase

B) No change Decrease

C) No change Increase

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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)

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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:

A) all-current method, and the total asset turnover ratio will be higher under the all-current method.

B) all-current method, and the total asset turnover ratio will be higher under the temporal method.

C) temporal method, and the total asset turnover ratio will be higher under the all-current method.

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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)

土豆妮

 

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:

A) $1,801 and $2,401.

B) $1,845 and $2,401.

C) $1,845 and $2,460.

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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.

土豆妮

Which of the following statements is most accurate concerning foreign currency translation?

A) In the case of an appreciating currency, the fixed asset turnover will be lower under the temporal method, as compared to the current rate method.

B) In the case in which a firm uses first in, first out (FIFO) inventory valuation, if the local currency appreciates the cost of good sold under the temporal method is less than the cost of goods sold using the current rate method.

C) The receivables turnover ratio is identical under both the temporal method and the current rate method.

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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.   

土豆妮

Which of the following ratios is affected by translation under the all-current method?

A) Net profit margin.

B) Debt/Assets ratio.

C) Fixed asset turnover ratio.

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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).

土豆妮

If Capriati uses the all-current method to translate Navratov’s income statement, the net profit margin will be:

A) 10.1%.

B) 8.6%.

C) 11.7%.

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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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What is the difference in the translated receivables turnover ratio for Navratov Corp. between the temporal and all-current methods? The receivables turnover rate is:

A) lower under the all-current method by 0.30x.

B) the same under both methods.

C) higher under the all-current method by 0.36x.

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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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What is the difference in the total asset turnover ratio for Navratov Corp. between the temporal and all-current methods? The total asset turnover ratio is:

A) higher under the all-current method.

B) the same under both methods.

C) lower under the all-current method.

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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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Given the observed appreciation or depreciation of the ruble versus the U.S. dollar, which of the following statements regarding Navratov’s leverage ratios under the temporal method compared to the all-current method is most accurate? The temporal method will lead to a:

A) higher debt-to-equity ratio and a higher debt-to-capital ratio.

B) higher debt-to-equity ratio and a lower debt-to-capital ratio.

C) lower debt-to-equity ratio and a lower debt-to-capital ratio.

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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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Capriati has completed his research and has summarized his findings in a report for Evert’s management. Which of the statements made in Capriati’s report is least accurate?

A) The statement of cash flows for Navratov Corp should be the same under both the temporal and all-current methods of translation.

B) Evert would prefer the temporal method for reporting its gross profit margin if the Russian Ruble was depreciating.

C) A depreciating foreign currency will have a smaller impact on Evert’s consolidated financial statements than an appreciating foreign currency.

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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)

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土豆妮

Which of the following statements regarding the effects of translation on financial ratios is least accurate?

A) Return ratios are affected because both the numerator and denominator are affected.

B) Depreciation is distorted in the temporal method.

C) Fixed assets are higher under the temporal method if the local currency appreciates.

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Fixed assets are lower under the temporal method if the local currency appreciates.

土豆妮

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:

A) lower than the gross profit margin as computed under the temporal method.

B) higher than the gross profit margin as computed under the temporal method.

C) equal to the gross profit margin as computed under the temporal method.

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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.