bigredhockey55

Assume that Scud Co. is a Swiss subsidiary of the U.S. firm Patriot, Inc. On December 31, 2007 the $/SF exchange rate was 0.77. (Each Swiss Franc buys 77 cents.) Assume that this is the historical rate, accept as noted below. One year later the Swiss Franc had appreciated to 0.85 $/SF. Scud Co. pays no dividends. The average exchange rate for the year was 0.80 $/SF. Scud pays no taxes. Assume that inventory is accounted for using the LIFO inventory assumption, was bought and sold evenly throughout the year, and that COGS is translated at the average rate for the year.

Scud Co. Int'l
Balance Sheet (in SF thousands)
	Dec. 31, 2007	Dec. 31, 2008
Cash & A/R	400	600
Inventory	500	500
Net Fixed Assets	700	600
Total Assets	1,600	1,700

A/P	100	200
Long-term debt	200	100
Common Stock	1,300	1,300
Retained Earnings	0	100
Total Liabilities	1,600	1,700

Income Statement (in SF thousands)
December 31, 2008
	In SF
Sales	7,000
COGS	(6,800)
Depreciation	(100)
Remeasurement Gain/Loss	--
Net Income	100

Assume that the functional currency is the U.S. dollar when answering the following questions.The level of cash on the 2008 remeasured balance sheet would be:

A) $510.

B) $480.

C) $462.

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The basis for using the current rate 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 U.S. dollar is the functional currency and the reporting currency, the temporal method should be used to remeasure the Swiss Franc into U.S. dollars. With the temporal method monetary assets like cash and monetary liabilities are remeasured at the current exchange rate. 600SF × 0.85$/SF = $510. (Study Session 6, LOS 24.d)

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The level of net fixed assets on the remeasured 2008 balance sheet would be:

A) $480.

B) $510.

C) $462.

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Net fixed assets are considered non-monetary assets. For non-monetary assets, the temporal method uses the historical rate: 600SF × 0.77$/SF = $462. (Study Session 6, LOS 24.d)

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Which of the following ratios may be larger in the presentation currency versus the local currency when translated under the current rate method?

A) Return on assets.

B) Current ratio.

C) Net profit margin.

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All pure income statement and balance sheet ratios are unaffected by the application of the current rate method. What we mean by “pure” is that the components of the ratio all come from the balance sheet, or the components of the ratio all come from the income statement. Return on assets is a “mixed ratio” because assets come from the balance sheet and are translated at the current rate and net income is translated at the average rate. Unless the exchange rate doesn’t change during the year, the two inputs will be translated at different rates, and the local currency value of the ratio will change when translated into the reporting currency. The other ratios will always be the same using the current rate method. (Study Session 6, LOS 24.d)

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The level of retained earnings on the remeasured 2008 balance sheet would be:

A) $305.

B) $85.

C) $101.

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To get this value, we need to finish remeasuring our balance sheet at the appropriate rates. The retained earnings figure will be what makes the balance sheet balance.

Scud Co. Int'l Balance Sheet (in SF thousands)
	Dec. 31, 2008	Remeasured $
Cash & A/R	600 × 0.85 =	10
Inventory	500 × 0.77 =	385
Net Fixed Assets	600 × 0.77 =	462
Total Assets	1,700	1,357
A/P	200 × 0.85 =	170
Long-term debt	100 × 0.85 =	85
Common Stock	1,300 × 0.77 =	1001
Retained Earnings	100	101
Total Liabilities and Owner's Equity	1,700	1,357

(Study Session 6, LOS 24.d)

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The level of sales on the remeasured income statement would be:

A) $5,390.

B) $5,600.

C) $5,950.

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Revenues and SG&A use the average exchange rate with both the temporal and current rate methods.
7000SF × 0.80$/SF = $5600
(Study Session 6, LOS 24.d)

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The translation gain or loss on the income statement would be:

A) $25.

B) $0.

C) $18.

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We need to complete our remeasurement of the income statement. Since beginning retained earnings for the year were zero, we know that net income on the remeasured income must be equal to ending retained earnings. The remeasurement gain or loss is the plug figure that causes this to be the case.

Income Statement (in SF thousands) December 31, 2008
Sales	7,000 × 0.80 =	$5,600
COGS	(6,800) × 0.80 =	$5,440
Depreciation	100 × 0.77 =	= $77
Income before remeasurement gain/loss		= $83
Remeasurement gain = Plug		= $18
Net Income		$101

(Study Session 6, LOS 24.d)

bigredhockey55

Walter Jameson, CFA®, is an analyst for Continental Corp., a global investment bank. Jameson has been assigned coverage of Wasson Brothers (WB), a large U.S. based conglomerate with many subsidiaries in both the U.S. and abroad. Jameson has completed his review of the firm’s U.S. operations, but his research report is due at the end of the week and he has yet to assess the impact of Wasson’s foreign subsidiaries on his earnings model.
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

Kasamatsu Industries Financial Data (12/31/02)
	Yen (in thousands)	Exchange Rate	U.S. Dollars (in thousands)
Sales	700,000
COGS	280,000
Depreciation	126,000
SG & A	77,000
Income Tax Expense	98,000
Net Income	119,000
2001 Retained Earnings	0
Dividends	58,000
2002 Retained Earnings	61,000
Current Assets	50,000
Fixed Assets	486,000
Current Liabilities	46,000
Long Term Debt	254,000
Capital Stock	175,000
Accumulated Translation Adjustment

The first step in Jameson’s analysis is to compute Kasamatsu’s impact on WB's net income. What is Kasamatsu’s impact on WB's net income (in thousands dollars)?

A) $821.

B) $793.

C) $850.

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The basis for using the current rate 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.

Because Kasamatsu is a wholly owned subsidiary of WB, all of its net income will be included in WB's. Kasamatsu’s local currency is also the functional currency, so the current rate method should be used to translate the financial statements into U.S. dollars. The appropriate exchange rate to use would be the average exchange rate for 2002, and no adjustment needs to be made for the dividend. The calculation is:

119,000 / 140 = 850

Therefore, WB will report an additional $850,000 of net income as a result of their subsidiary's operating results. Both remaining answers use incorrect exchange rates. (Study Session 6, LOS 24.e)

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Jameson now computes the adjustment to WB's financial data due to Kasamatsu's payment of dividends. What is the U.S. dollar amount of this adjustment (in thousands)?

A) $414.

B) $400.

C) $387.

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WB receives a cash dividend from their subsidiary. This dividend must be translated at the prevailing exchange rate on the date the dividend is received (145/$). $58,000 / 145 = 400. Both remaining answers use incorrect exchange rates. (Study Session 6, LOS 24.e)

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The carrying value of Kasamatsu’s total assets on December 31, 2002, using the current rate method of accounting for translations is:

A) $3,573.

B) $3,240.

C) $5,360.

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Under the current rate method, all balance sheet accounts, with the exception of equity, are translated at the current rate. At the current rate of 150 under the current rate method, the amount is: (486,000 + 50,000) / 150 = $3,573. (Study Session 6, LOS 24.d)

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The yen has depreciated against the dollar in the last year. If the exchange rate in 2001 was in effect during 2002, under the current rate method the reported cost of goods sold would have been:

A) higher by $287.

B) lower by $333.

C) higher by $333.

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Under the current rate method, COGS is translated at the average rate in effect during the reporting period. Using the average exchange rate during 2002, COGS is calculated as 280,000 / 140 = $2,000. Using the average rate in effect during 2001 results in COGS of $2,333 (280,000 / 120), or $333 higher. (Study Session 6, LOS 24.d)

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Jameson has prepared a report assessing the impact of the currency translation on Kasamatsu’s financial ratios. The details of his report are as follows:

• Quick ratio: higher
• Total asset turnover: higher

With respect to the direction of changes for the ratios, Jameson is:

A) correct with respect to the quick ratio, but incorrect with respect to the total asset turnover ratio.

B) incorrect with respect to the quick ratio, but correct with respect to the total asset turnover ratio.

C) incorrect with respect to the quick ratio, and incorrect with respect to the total asset turnover ratio.

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For the quick ratio, both current assets (with the exception of inventory) and current liabilities will be translated at the current rate. The ratio will be unchanged, so Jameson is incorrect with respect to this one.

For the total asset turnover ratio, sales will be translated at the average rate, while assets will be translated at the current rate. Since the currency is depreciating, the rate used to translate sales will be higher than the rate used to translate assets, resulting in a higher total asset turnover ratio. Jameson is correct with respect to the direction of change for this one. (Study Session 6, LOS 24.d)

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Having converted all of Kasamatsu’s accounts using the current rate methods, Jameson is curious to compare the difference between the temporal and current rate methods on balance sheet accounts. The difference in translated fixed assets and long term debt respectively if Jameson were to use the temporal method rather than the current rate method is:

Fixed Assets

Long-Term Debt

A) $0 $0

B) $1620 $0

C) $1620 $121

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Fixed assets under the temporal method, are reported at historical translation rates. 486,000 / 100 = $4,860. Under current rate, fixed assets are translated at the current rate (486,000 / 150) = $3,240, a difference of $1,620.
Even though it is a balance sheet account, under the temporal method, long term debt is considered a monetary liability and is translated at the current rate. Under the current rate method, long-term debt is also translated at the current rate, so the difference between the two methods is $0. (Study Session 6, LOS 24.d)

bigredhockey55

Navratov Corp. is a designer and manufacturer of high end sporting goods. The majority of the firm’s business comes from Olympic athletes from Russia and the United States. On January 1, 2003, Navratov was purchased by a U.S. competitor, Evert Industries. Because Evert’s business focuses on professional athletes in North America and Asia, Evert’s management feels the acquisition of Navratov is a natural extension of their business and that buying the Russian firm should generate economies of scale.
Peter Capriati is an analyst for Evert and has been assigned the task of integrating Navratov’s financial statements into Evert’s. Capriati knows that Evert’s management pays a great deal of attention to making sure the firm’s financial ratios are above the industry average. Because Navratov’s sales are split evenly between the U.S. and Russia, management has given him the flexibility to designate the either the Ruble (Navratov’s local currency) or the U.S. dollar (Evert’s reporting currency) as Navratov’s functional currency. As a result of choosing the functional currency, Capriati will use either the temporal or current rate method to convert Navratov’s financial statements, depending on which method will have the most favorable impact on Evert’s financial ratios.
Selected financial data for Navratov Corp is shown below:

Navratov Corporation Income Statement (in Russian Rubles) 12 months ended December 31, 2003
Revenue	7,400,000
Cost of Goods Sold (COGS)	(5,200,000)
Depreciation	(1,200,000)
Taxes	(250,000)
Net Income	750,000

Navratov Corporation Balance Sheet (in Russian Rubles) December 31, 2002
Assets			Liabilities and Equity
Cash	500,000		Accounts Payable	3,450,000
Accounts Receivable	2,500,000		Long Term Debt	5,000,000
Inventory	3,700,000		Common Stock	3,500,000
Net Fixed Assets	6,000,000		Retained Earnings	750,000
Total Assets	12,700,000		Total Liabilities and Equity	12,700,000

Navratov Corporation Balance Sheet (in Russian Rubles) December 31, 2003
Assets			Liabilities and Equity
Cash	1,000,000		Accounts Payable	2,000,000
Accounts Receivable	2,500,000		Long Term Debt	5,000,000
Inventory	3,700,000		Common Stock	3,500,000
Net Fixed Assets	4,800,000		Retained Earnings	1,500,000
Total Assets	12,000,000		Total Liabilities and Equity	12,000,000

• Navratov Corp. did not pay dividends in 2003.
• The common stock was acquired on January 1, 2002.
• January 1, 2003 retained earnings in USD is $300,000.
• Depreciation is being taken on a straight-line basis over ten years for equipment which was acquired on January 1, 2002, at a cost of 12,000,000 rubles.
• Navratov uses FIFO inventory accounting and goods were sold evenly throughout the year. The average rate applicable to inventory and COGS is $0.37 / ruble.

Exchange rates:

• January 1, 2002, $0.40 / ruble
• January 1, 2003, $0.40 / ruble
• June 30, 2003, $0.37 / ruble (avg. rate)
• December 31, 2003, $0.33 / ruble

Which of the following statements about the temporal method and the current rate method is least accurate?

A) Subsidiaries that operate in highly inflationary environments will generally use the temporal method under U.S. GAAP.

B) Subsidiaries whose operations are well integrated with the parent will generally use the current rate method.

C) Net income is generally more volatile under the temporal method than under the current rate method.

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Subsidiaries whose operations are well integrated with the parent will generally use the parent’s currency as the functional currency. Remeasurement from the local currency to the functional currency is done with the temporal method. (Study Session 6, LOS 24.c)

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If Capriati uses the current rate 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 current rate method. The calculation is shown below:
Under the current rate 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 current rate 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 current rate methods? The receivables turnover rate is:

A) lower under the current rate method by 0.30x.

B) the same under both methods.

C) higher under the current rate method by 0.36x.

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The receivables turnover ratio is calculated as (sales / receivables). Under the both the current rate 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 current rate methods? The total asset turnover ratio is:

A) higher under the current rate method.

B) the same under both methods.

C) lower under the current rate 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 current rate method. This is because all assets are translated at the current rate under the current rate 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 current rate 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 current rate 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 current rate 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 current rate 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 current rate method.
Assets under the temporal method are also effectively translated at a mixed rate under the temporal method, and the current rate under the current rate 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 current rate 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 current rate 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 current rate method. Under both the temporal and current rate 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 current rate 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)

bigredhockey55

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

A) Net profit margin.

B) Fixed asset turnover ratio.

C) Debt/Assets ratio.

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Recall that all pure income statements and balance sheet ratios are unaffected by translation under the current rate 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).

rgonzalez

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

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

B) 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.

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 the appropriate rates to use for cost of goods sold (COGS) are the older historical rates. The average rate is used for COGS under the current rate method. If the local currency depreciates, COGS would be higher under the temporal 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.   

rgonzalez

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 $2,460.

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

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The basis for using the current rate 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.

rgonzalez

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.

rgonzalez

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:

A) lower than the same ratio computed under the temporal method.

B) higher than the same ratio computed under the temporal method.

C) either higher or lower than the same ratio computed under the temporal method.

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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.

rgonzalez

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

B) lower 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.It may help to 'think' that with the current rate method, you use the average rate for COGS, which makes COGS higher because the currency has appreciated.

rgonzalez

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.