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

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

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

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

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 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 Tool & Die Company Balance Sheet As of December 31, 2005
	Chad (millions)		Exchange Rate (Chad/US$)		U.S. $ (millions)
Cash	20		0.25		$80
Accounts receivable	30		0.25		120
Inventory	100		0.3125		320
Fixed assets (net)	500		0.3333		1,500
Total assets	650				$2,020
Accounts payable	50		0.25		$200
Capital stock	380		0.3333		1,140
Retained earnings	220		--		680
Total liabilities and equity	650				$2,020

Acer Tool & Die Company Income Statement For year ending December 31, 2005 (Amounts in millions of Chad)
Revenues	1,000
Cost of sales	700
Depreciation expense	50
Selling expense	30
Translation gain (or loss)
Net income	220

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. Assume that retained earnings at year end 2004 were zero, the historical exchange rate for depreciation is 0.333, and no dividends were paid during 2005.What is Acer Tool & Die's cost of sales in U.S. dollars using the temporal method?

A) $2,222.

B) $2,242.

C) $2,240.

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

	Chad	Conversion	US$
Beginning inventory	90	0.3333	$270
Purchases	710	0.3125	2,272
Ending inventory	100	0.3125	320
COGS	700		$2,222

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What is the remeasurement gain or loss for the period using the temporal method?

A) $50 gain.

B) $52 loss.

C) $32 loss.

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Remeasured income statement under temporal method:
Revenues = 1000/0.3125 = 3200
COGS = 2222 (from previous question)
Depreciation = 50/0.3333 = 150
Selling expense = 30/0.3125 = 96
Income before remeasurement gain = 3200 − 2222 − 150 − 96 = 732
Net income = 680 (= retained earnings at year end 2005 − retained earnings at year end 2004)
Remeasurement gain/loss = 680 − 732 = -52

rgonzalez

Dell 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.

Assets			Liabilities and Equity
Cash	200		A/P	180
A/R	240		Common Stock	720
Maintenance Supplies	180
Fixed Assets	280
Total Assets	900		Total Liab & Equity	900

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

Sales	3,500
Total Costs	2,900
Net Income	600

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:

Assets			Liabilities and Equity
Cash	441		A/P	210
A/R	330		Common Stock	720
Supplies	291		Retained Earnings	600
Fixed Assets	468
Total Assets	1,530		Total Liab. & Equity	1,530

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

A) $300.

B) $200.

C) $240.

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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 Australian dollar 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. The average rate is (2 + 3) / 2 = 2.5 Australian dollars = $1. (Study Session 6, LOS 24.d)

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On 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) $360.

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Since the Australian dollar 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
(Study Session 6, LOS 24.d)

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

A) $200.

B) $240.

C) $300.

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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 $)

Sales (3,500 / 2.5)	$1,400
Costs (2,900 / 2.5)	$1,160
Net Income	$240

(Study Session 6, LOS 24.d)

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

A) −$220.

B) −$280.

C) −$160.

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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. Total assets = 1530/3 = 510 and accounts payable = 210/3 = 70. The common stock is translated at the historical rate on the date of purchase = 720/2 = 360. Beginning retained earnings = 0, so ending retained earnings = translated net income = 240. The cumulative translation adjustment is the plug figure that makes the balance sheet balance = 510 − 70 − 360 − 240 = -160. (Study Session 6, LOS 24.d)

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

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

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

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

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The conditions necessary for implementation of the temporal method are:

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

(Study Session 6, LOS 24.c)

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

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

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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. (Study Session 6, LOS 24.c)

rgonzalez

Dell Air Lines has recently acquired Australian Puddle Jumpers, Inc. (APJ), 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, 2001 in U.S. dollars.

Assets			Liabilities and Equity
Cash	$100		Accounts Payable (A/P)	$90
Accounts Receivable (A/R)	120		Common Stock	360
Maintenance Supplies	90
Fixed Assets	140
Total Assets	$450		Total Liabilities & Equity	$450

APJ's income statement for the year ending Dec. 31, 2002 is expressed in Australian dollars as:

Sales	3,500
Total Costs	2,900
Net Income	600

The Australian dollar has steadily depreciated against the U.S. dollar. At Dec. 31, 2001, the exchange rate was 2.5 Australian dollars = $1 but at Dec. 31, 2002, the exchange rate had deteriorated to 3 Australian dollars = $1.
The Dec. 31, 2002 Balance Sheet for APJ is given in Australian dollars as follows:

Assets			Liabilities and Equity
Cash	441		A/P	210
A/R	330		Common Stock	720
Supplies	291		Retained Earnings	600
Fixed Assets	468
Total Assets	1,530		Total Liabilities & Equity	1,530

On APJ's 2002 income statement, the level of sales in U.S. dollars would be:</FONT

A) $1,272.</FONT

B) $1,985.</FONT

C) $1,167.</FONT

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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 Australian dollar is the functional currency, use the current rate method. The items in the income statement are translated at the average exchange rate. The average rate is (2.5 + 3) / 2 = 2.75 Australian dollars = $1.

Income Statement (in $)

Sales (3,500 / 2.75)	$1,272
Costs (2,900 / 2.75)	$1,055
Net Income	$217

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On APJ's 2002 income statement, the level of net income in U.S. dollars would be:

A) $242.

B) $200.

C) $217.

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Since we are using the current rate method, the items in the income statement are translated at the average exchange rate. The average rate is (2.5 + 3) / 2 = 2.75 Australian dollars = $1.

Income Statement (in $)

Sales (3,500 / 2.75)	$1,272
Costs (2,900 / 2.75)	$1,055
Net Income	$217

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On APJ's 2002 balance sheet, the level of accounts receivable is U.S. dollars would be:

A) $330.

B) $110.

C) $132.

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Since we are using 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.

A/R (330 / 3) = 110

rgonzalez

Giant Company is a U.S. firm that produces parts for nuclear reactors. Giant Company has a subsidiary, Grande, Inc., that operates in Mexico and is responsible for designing and manufacturing connection fittings that are vital for the proper operation of its parent company’s reactors.

• Giant Company considers the U.S. dollar to be the functional currency of Grande, Inc.
• Grande, Inc., began operations January 1, 2001.
• Common Stock and Fixed Assets were acquired January 1, 2000.
• Inventory is accounted for under the last in, first out (LIFO) cost flow assumption, and was purchased evenly through the year.
• The inventory in the January 1, 2001, Balance Sheet was acquired on January 1, 2001.

Exchange Rates were:	January 1, 2000	$0.14/M peso
	January 1, 2001	$0.12/M peso
	June 30, 2001	$0.11/M peso (this is the 2001 average rate)
	December 31, 2001	$0.10/M peso

Grande, Inc.
Balance Sheet (in M Pesos)
	Jan. 1, 2001	Dec. 31, 2001
Cash	5,000,000	20,000,000
Accounts Receivable	20,000,000	35,000,000
Inventory	15,000,000	15,000,000
Fixed Assets (net)	70,000,000	60,000,000
Accounts Payable	10,000,000	10,000,000
Long Term Debt	40,000,000	35,000,000
Common Stock	80,000,000	80,000,000
Retained Earnings		5,000,000
2001 Income Statement
(in M Pesos)
Sales	60,000,000
Cost of Goods Sold	(45,000,000)
Depreciation	(10,000,000)
Net Income	5,000,000

Giant Company should use the following method to reflect the results of Grande, Inc., in its financial statements:

A) the temporal method.

B) the temporal method followed by the current rate method.

C) 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.

The temporal method is used when the functional currency is the parent’s currency. (Study Session 6, LOS 24.c)

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The Cost of Goods Sold for Grande, Inc., for the year ended December 31, 2001, expressed in U.S. dollars is:

A) $5,400,000.

B) $5,250,000.

C) $4,950,000.

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Both the beginning and ending inventory under LIFO cost flow assumptions are translated at the $0.12 rate as of the date the original inventory was acquired, January 1, 2001. Because beginning and ending inventories expressed in Mexican pesos are equal, the purchases for the year will equal the Cost of Goods Sold, which is remeasured at the average cost of acquiring the goods during the year: $0.11. (45,000,000 × $0.11) = $4,950,000. The average rate is the best estimate of the historical rate because the inventory that was sold was purchased evenly through the year. (Study Session 6, LOS 24.c)

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Which of the following statements regarding the current rate method are most correct?

A) This method is not typically used when the subsidiary is relatively independent of the parent.

B) Revenues and expenses are translated at the historic rate.

C) Under this method, translation gains and losses are reported in equity in the CTA account.

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Under the current rate method, translation gains and losses are reported in equity in the CTA account. This method is typically used when the subsidiary is relatively independent of the parent. Revenues and expenses are translated at the average rate.
(Study Session 6, LOS 24.c)

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The translation gain or loss from the activities of Grande, Inc., should be reported in:

A) the statement of cash flows.

B) the income statement.

C) the statement of shareholder’s equity.

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Under the temporal method, translation gains and losses are included in the income statement. (Study Session 6, LOS 24.d)

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Revenues for 2001 translated into U.S. dollars amount to:

A) $6,600,000.

B) $6,000,000.

C) $7,800,000.

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Under the temporal method, revenues are translated at the average rate during the reporting period.
60,000,000 × 0.11 = $6,600,000
(Study Session 6, LOS 24.d)

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As a result of making the appropriate currency adjustments to the financial statements, Grande Inc.’s December 31, 2001 quick ratio will be:

A) higher.

B) unchanged.

C) lower.

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Since the functional currency is the reporting currency, the temporal method must be used. Since it is taking fewer dollars to buy a peso, the peso is depreciating.

The quick ratio is a liquidity ratio that does not include inventory. The quick ratio is calculated as [(cash + accounts receivable) / accounts payable]. Since monetary assets and liabilities are translated at the current rate, the quick ratio will be unchanged. (Study Session 6, LOS 24.d)