rgonzalez

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?

A) The ratio will fall.

B) The ratio will not change.

C) The ratio will rise.

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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. Note: When equity is broken out into separate accounts, common stock is taken at the historical rate. When taken as a whole, equity should be translated at the current rate. In this case we are not given any information on the common stock amount, so we translate equity at the current rate.

rgonzalez

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 fall.

C) The ratio will rise.

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Since the dollar has appreciated, the local currency has depreciated, so each foreign currency unit bought 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 lower.

rgonzalez

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 fall.

C) The ratio will rise.

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Since the dollar has appreciated, the local currency has depreciated, so each foreign currency unit bought 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 lower.

rgonzalez

Which of the following ratios is unaffected by the choice between the current rate method and the temporal method?

A) Accounts payable turnover.

B) Quick ratio.

C) Current 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 current rate method. Accounts payable turnover is purchases/accounts payable. Purchases is an inventory item (like COGS) that may not use the same rate under the temporal method and the current rate method.

rgonzalez

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. The management team for Hise now makes all operating, financing, and investment decisions. Brian Heltzel, a financial analyst for Hise, is responsible for translating Wilson’s financial statements from U.S. dollars to the reporting currency. Hise conducts its business and issues financial statements in British pounds (£).

Wilson Tile and Stone – December 31, 2007 and 2008 Balance Sheets
	2007	2008
Cash	$1,200	$1,400
Accounts receivable	6,500	9,900
Inventory	10,400	12,400
Current assets	$18,100	$23,700
Fixed assets	40,000	40,000
Accumulated depreciation	10,000	15,000
Net fixed assets	$30,000	$25,000
TOTAL ASSETS	$48,100	$48,700
Accounts payable	$5,000	$6,000
Current portion of LT debt	1,500	1,500
Long term debt	25,000	23,500
Total liabilities	$31,500	$31,000
Common stock	10,000	10,000
Retained earnings	6,600	7,700
Total equity	$16,600	$17,700
TOTAL LIABILITIES and EQUITY	$48,100	$48,700

Wilson Tile and Stone – 2008 Income Statement
Revenue	$75,000
Cost of goods sold	(60,000)
Gross margin	$15,000
Other expenses	(2,300)
Depreciation expense	(5,000)
Net Income	$7,700

Wilson uses the FIFO method for inventory accounting.
Applicable exchange rates are as follows:

• December 31, 2007: £1.00 = $1.60
• December 31, 2008: £1.00 = $1.80
• Average for 2008 = £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 most accurate?

A) The British pound is the reporting currency and Heltzel should use the current rate method.

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

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

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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.
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. (Study Session 6, LOS 23.c)

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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 £3,529

B) £41,667 £3,333

C) £44,118 £3,333

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Since the British pound is the functional currency, the temporal method should be used. Under both the current rate 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 current rate 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 23.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) £285.

C) £1,012.

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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 23.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) No change Increase

B) Increase Increase

C) No change Decrease

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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 23.d)

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Heltzel decides to redefine the functional currency to assess how the current rate vs. the temporal method will impact Wilson’s financial statements. Wilson’s gross profit margin will be lower under the:

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

B) current rate 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 current rate 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 current rate method. Non-monetary assets are converted at the historical rate using the temporal method and the current rate under the current rate method. The depreciating local currency means that total assets will be lower under the current rate method. The lower denominator will lead to a higher total asset turnover ratio under the current rate method. (Study Session 6, LOS 23.d)

rgonzalez

Where does the currency translation gain or loss appear in the financial statements under the temporal method and the current rate method?

Temporal method

Current rate method

A) Income statement Balance sheet

B) Balance sheet Income statement

C) Balance sheet Balance sheet

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Currency translation gain or loss appears on the income statement under the temporal method and the balance sheet under the current rate method.

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.

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

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

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.